Question

"Shareholders will always prefer a cash dividend to a share dividend while the company prefers the reverse". Why might this be the case?

(Think about the journal entry for both.)

Answer 1

Let us evaluate the reasons for the same

A dividend is a distribution of the companies earnings and its main purpose is to return wealth back to the shareholders.

Cash Dividend

• Shareholder receive regular cash income as there is a cash inflow
• Shareholders might need to pay tax.

Cash dividend entries

Eg. XYZ corporation – 10000 shares outstanding has cash dividend of $0.3

31^stMarch Retained earnings ( 10,000 * 0.3) Dr 3000

                     to dividend payable                          Cr 3000

( being dividend declared on 31^stMarch)

30 June      Dividend payable                       Dr 3000

                     to cash and bank account            Cr 3000

( being cash dividend paid to shareholders)

Stock Dividend

Eg. XYZ corporation – 10000 shares outstanding has stock dividend of 0.3 )

i.e 3 shares for every 10 shares held by shareholder

However, it is to be noted that the market value and will dilute the price value per share.

Hence if par value is $1 and value of share is $10,

Current market value = 10,000 shares * 10$ = $100,000

As stock dividend will be 3000 shares, number of shares after stock dividend will be ( 10,000+3000) = 13000

Market value per share will be 100,000$/13000 = $7.69

Stock dividend entries

31^stMarch Retained earnings ( $3000*10)     Dr  30000

       to Paid up capital in excess of par             cr 27000

      to common stock dividend distributable ( $3000 * 1)      Cr 3000

( being stock dividend declared)

30^thJune

Common stock dividend distributable Dr 3000

Common stock                                            Cr 3000

Reasons

1. As seen above, shareholders with a short term view like cash dividend as they receive liquid cash in their account
2. Companies declaring cash dividend results in lower cash balances after payment
3. Stock dividend gives the company chance to protect its cash and liquidity position. They give the shareholders the option to convert it into cash by selling the shares or retaining the stock.
4. Shareholders would also have to note that cash dividend results in payment of tax but stock dividend does not attract tax
5. Cash dividend also will result in lower cash resulting into drop in the share price of the company. Stock dividend does not result in increase in share price, but the prices would remain the same.

These are the various reasons why shareholders with a short term view prefer cash dividend but companies prefer stock dividend.