dividend

dividend

[div-i-dend]
dividend, that part of the net earnings of a corporation that is distributed to its stockholders. Dividend disbursements are based on a percentage of the par value of the stock or are a certain sum per share of no-par-value stock. They become payable only when approved by the board of directors and are usually declared at regular intervals. Obviously, dividends should not be paid unless the company has accumulated a profit or surplus. In the United States, dividends may be paid in property of various kinds, including bonds and stocks of the company or stocks of other companies first acquired for other purposes, in notes, or in cash. Dividends may be paid in stocks when the accumulated profits of a company are to be retained for reinvestment in the business. Dividends in the form of notes, often called scrip dividends, are rare; they are only paid when the company has earnings that it expects to convert into cash before the notes are due. In Great Britain, dividends are payable only in cash. Liquidation dividends are the return of the capital of a business that is being terminated. Enterprises with diminishing assets, such as mines, issue a modified form of liquidation dividend. The dividend from preferred shares of stock is a fixed percentage that must be paid before the remainder of the profit is divided among other shares. If there are not enough profits to pay the whole dividend on preferred stock, future profits may be assigned to pay back those dividends before anything is paid on common stock. Preferred stock is ranked as first and second preferred, according to the priority of its obligations. Preferred dividends differ from interest on bonds in that there is no default if the former are not paid. The term dividend is also used to refer to a fractional payment of the amount owed by a bankrupt firm to a creditor.

Individual share of earnings distributed among stockholders of a corporation or company in proportion to their holdings. Usually paid in cash, dividends may also be distributed in the form of additional shares of stock. Preferred stockholders receive a preferential dividend, usually at a fixed rate; common stockholders get a portion of what remains after payment of the dividends on preferred stock.

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Dividends are payments made by a corporation to its shareholder members. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend.

For a joint stock company, a dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding. For the joint stock company, paying dividends is not an expense; rather, it is the division of an asset among shareholders. Public companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from a regular one.

Cooperatives, on the other hand, allocate dividends according to members' activity, so their dividends are often considered to be a pre-tax expense.

Dividends are usually settled on a cash basis, as a payment from the company to the shareholder. They can take other forms, such as store credits (common among retail consumers' cooperatives) and shares in the company (either newly-created shares or existing shares bought in the market.) Further, many public companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder.

Joint stock company dividends

Forms of payment

Cash

Cash dividends (most common) are those paid out in the form of a cheque. Such dividends are a form of investment income and are usually taxable to the recipient in the year they are paid. This is the most common method of sharing corporate profits with the shareholders of the company.

For each share owned, a declared amount of money is distributed. Thus, if a person owns 100 shares and the cash dividend is $0.50 per share, they will receive $50.00 in total.

Stock

Stock or scrip dividends are those paid out in form of additional stock shares of the issuing corporation, or other corporation (such as its subsidiary corporation). They are usually issued in proportion to shares owned (for example, for every 100 shares of stock owned, 5% stock dividend will yield 5 extra shares). If this payment involves the issue of new shares, this is very similar to a stock split in that it increases the total number of shares while lowering the price of each share and does not change the market capitalization or the total value of the shares held (see also Stock dilution).

Property

Property dividends or dividends in specie (Latin for "in kind") are those paid out in form of assets from the issuing corporation or another corporation, such as a subsidiary corporation. They are relatively rare and most frequently are securities of other companies owned by the issuer, however they can take other forms, such as products and services.

Other

Dividends can be used in structured finance. Financial assets with a known market value can be distributed as dividends; warrants are sometimes distributed in this way.

For large companies with subsidiaries, dividends can take the form of shares in a subsidiary company. A common technique for "spinning off" a company from its parent is to distribute shares in the new company to the old company's shareholders. The new shares can then be traded independently.

Dates

Dividends must be "declared" (approved) by a company’s Board of Directors each time they are paid. For public companies, there are four important dates to remember regarding dividends. These are discussed in detail with examples at the Securities and Exchange Commission site

Declaration date

The declaration date is the day the Board of Directors announces its intention to pay a dividend. On this day, a liability is created and the company records that liability on its books; it now owes the money to the stockholders. On the declaration date, the Board will also announce a date of record and a payment date.

Ex-dividend date

The ex-dividend date is the day on which all shares bought and sold no longer come attached with the right to be paid the most recently declared dividend. This is an important date for any company that has many stockholders, including those that trade on exchanges, as it makes reconciliation of who is to be paid the dividend easier. Prior to this date, the stock is said to be cum dividend ('with dividend'): existing holders of the stock and anyone who buys it will receive the dividend, whereas any holders selling the stock lose their right to the dividend. On and after this date the stock becomes ex dividend: existing holders of the stock will receive the dividend even if they now sell the stock, whereas anyone who now buys the stock will not receive the dividend.

It is relatively common for a stock's price to decrease on the ex-dividend date by an amount roughly equal to the dividend paid. This reflects the decrease in the company's assets resulting from the declaration of the dividend. The company does not take any explicit action to adjust its stock price; in an efficient market, buyers and sellers will automatically price this in.

Record date

Shareholders who properly registered their ownership on or before the date of record will receive the dividend. Shareholders who are not registered as of this date will not receive the dividend. Registration in most countries is essentially automatic for shares purchased before the ex-dividend date.

Payment date

The payment date is the day when the dividend cheques will actually be mailed to the shareholders of a company or credited to brokerage accounts.

Dividend-reinvestment plans

Some companies have dividend reinvestment plans, or DRIPs. These plans allow shareholders to use dividends to systematically buy small amounts of stock, usually with no commission and sometimes at a slight discount. In some cases the shareholder might not need to pay taxes on these re-invested dividends, but in most cases they do.

Dividend reinvestment plans-in case of mutual funds: When the dividend is paid in cash it will attract the dividend distribution tax (DDT) and the same is not taxable in the hands of the person, but in case of dividend reinvestment plan where the dividend is not paid in cash but distributed as additional units will not attract the DDT and the same will be taxable in the hands of the person as capital gains when he realises the gain by selling the units.


Cons

  • Management and the board may believe that the money is best re-invested into the company: research and development, capital investment, expansion, etc. Proponents suggest that a management eager to return profits to shareholders may have run out of good ideas for the future of the company. Some studies have demonstrated that companies that pay dividends have higher earnings growth, however, suggesting that dividend payments may be evidence of confidence in earnings growth and sufficient profitability to fund future expansion.
  • When dividends are paid, individual shareholders in many countries suffer from double taxation of those dividends: the company pays income tax to the government when it earns any income, and then when the dividend is paid, the individual shareholder pays income tax on the dividend payment; in many countries, the tax rate on dividend income is lower than for other forms of income to compensate for tax paid at the corporate level. Taxation of dividends is often used as justification for retaining earnings, or for performing a stock buyback, in which the company buys back stock, thereby increasing the value of the stock left outstanding. In contrast, corporate shareholders often do not pay tax on dividends because the tax regime is designed to tax corporate income (as opposed to individual income) only once. The shareholder will pay a tax on capital gains (which is often taxed at a lower rate than ordinary income) only when the shareholder chooses to sell the stock. If a holder of the stock chooses to not participate in the buyback, the price of the holder's shares should rise, but the tax on these gains is delayed until the actual sale of the shares. Certain types of specialized investment companies (such as a REIT in the U.S.) allow the shareholder to partially or fully avoid double taxation of dividends.
  • Shareholders in companies which pay little or no cash dividends can reap the benefit of the company's profits when they sell their shareholding, or when a company is wound down and all assets liquidated and distributed amongst shareholders. This, in effect, delegates the dividend policy from the board to the individual shareholder.
  • Payment of a dividend can increase the borrowing requirement, or leverage, of a company.

Miscellaneous specific types

Franking credits

In Australia and New Zealand, companies also forward franking credits to shareholders along with dividends. These franking credits represent the tax paid by the company upon its pre-tax profits. One dollar of company tax paid generates one franking credit. Companies can forward any proportion of franking up to a maximum amount that is calculated from the prevailing company tax rate: for each dollar of dividend paid, the maximum level of franking is the company tax rate divided by (1 - company tax rate). At the current 30% rate, this works out at 0.30 of a credit per 70 cents of dividend, or 42.857 cents per dollar of dividend. The shareholders who are able to use them offset these credits against their income tax bills at a rate of a dollar per credit, thereby effectively eliminating the double taxation of company profits. This system is called dividend imputation.

The UK's taxation system operates along similar lines: when a shareholder receives a dividend, the basic rate of income tax is deemed to already have been paid on that dividend. This ensures that double taxation does not take place, however this creates difficulties for some non-taxpaying entities such as certain trusts, charities and pension funds which are not allowed to reclaim the deemed tax payment and thus are in effect taxed on their income.

Reliability of dividends

There are two metrics which are commonly used to gauge the sustainability of a firm's dividend policy.

Payout ratio is calculated by dividing the company's dividend by the earnings per share. A payout ratio of more than 1 means the company is paying out more in dividends for the year than it earned.

Dividend cover is calculated by dividing the company's cash flow from operations by the dividend. This ratio is apparently popular with analysts of income trusts in Canada.

Other corporate dividends

Cooperatives

Cooperative businesses may retain their earnings, or distribute part or all of them as dividends to their members. They distribute their dividends in proportion to their members' activity, instead of the value of members' shareholding. Therefore, co-op dividends are often treated as pre-tax expenses.

Consumers' cooperatives allocate dividends according to their members' trade with the co-op. For example, a credit union will pay a dividend to represent interest on a saver's deposit. A retail co-op store chain may return a percentage of a member's purchases from the co-op, in the form of cash, store credit, or equity. This type of dividend is sometimes known as a patronage dividend or patronage refund, as well as being informally named divi or divvy.

Producer cooperatives, such as worker cooperatives, allocate dividends according to their members' contribution, such as the hours they worked or their salary.

Trusts

In real estate investment trusts and royalty trusts, the distributions paid often will be consistently greater than the company earnings. This can be sustainable because the accounting earnings do not recognize any increasing value of real estate holdings and resource reserves. If there is no economic increase in the value of the company's assets then the excess distribution (or dividend) will be a return of capital and the book value of the company will have shrunk by an equal amount. This may result in capital gains which may be taxed differently than dividends representing distribution of earnings.

Mutuals

The distribution of profits by other forms of mutual organization also varies from that of joint stock companies, though may not take the form of a dividend.

In the case of mutual insurance, for example, in the United States, a distribution of profits to holders of participating life policies is called a dividend. These profits are generated by the investment returns of the insurer's general account, in which premiums are invested and from which claims are paid. The participating dividend may be used to decrease premiums, or to increase the cash value of the policy. Some life policies pay nonparticipating dividends. As a contrasting example, in the United Kingdom, the surrender value of a with-profits policy is increased by a bonus, which also serves the purpose of distributing profits. Life insurance dividends and bonuses, while typical of mutual insurance, are also paid by some joint stock insurers.

Insurance dividend payments are not restricted to life policies. For example, general insurer State Farm Mutual Automobile Insurance Company can distribute dividends to its vehicle insurance policyholders.

Etymology and related uses

The word "dividend" comes from the Latin word "dividendum" meaning "the thing which is to be divided".

Footnotes

See also

External links

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