FIN 614: Financial Management
Larry Schrenk, Instructor
1. Stock Splits
2. Stock Dividends
3. Dividend Reinvestment Plans (DRIP)
Stock Splits: Firm divides its existing shares
into multiple shares
Like a stock dividend except it is expressed as
a ratio
For example, a 2 for 1 stock split is the same as
a 100% stock dividend.
Stock price is reduced when the stock
splits.
Common explanation for split is to return
price to a “more desirable trading range.”
Shares of stock are merged to form a
smaller number of proportionally more
valuable shares.
There are many ways to do this
One simple way is for the corporation to
cancel a uniform fraction of each
shareholder's shares
Stock splits can be used to keep the
price in the optimal range.
But most stocks are purchased by
institutional investors who have millions
to invest and are indifferent to price
levels. Plus, stock splits and stock
dividends are expensive!
Stock splits generally occur when
management is confident, so are
interpreted as positive signals.
Pay additional shares of stock instead of
cash
Increases the number of outstanding shares
Small stock dividend
Less than 20 to 25%
Large stock dividend
More than 20 to 25%
Stock Dividend
Firm issues new shares in lieu of paying a
cash dividend. If 10%, get 10 shares for
each 100 shares owned
Stock Split:
Firm increases the number of shares
outstanding, say 2:1
Gives shareholders more shares
Both stock dividends and stock splits increase
the number of shares outstanding, so “the pie
is divided into smaller pieces.”
Stock Splits and Stock Dividends are
economically the same
The number of shares outstanding increases and
the price of each share drops
The value of the firm does not change.
Unless the stock dividend or split conveys
information, or is accompanied by another
event like higher dividends, the stock price
should fall so as to keep each investor’s
wealth unchanged.
Shareholders can automatically reinvest
their dividends in shares of the
company’s common stock.
Get stock versus cash
There are two types of plans:
Open Market
New Stock
Firm issues new stock to DRIP enrollees,
keeps money and uses it to buy assets.
No fees are charged, plus sells stock at
discount of 5% from market price, which
is about equal to flotation costs of
underwritten stock offering.
FIN 614: Financial Management
Larry Schrenk, Instructor