Question

Discuss the differences between a stock dividend and a stock split. Why are these actions important to stockholders?

Answer 1

Stock Dividend:- It includes payment of dividend but instead of paying in cash company pays stock hence it is called as stock dividend. It is just like cash dividend paid by the company. For Example, If company pays 10% of stock dividend, then it means 1 share is provided for every 10 shares held. In this case retained earnings are used to declare and pay dividends. Here shareholder funds will increase due to increase in no. of shares given as dividend.

Stock Split:- It includes splitting of 1 share into multiple shares as per the company's preference. Stock splits occur when a company perceives that its stock price may be too high. Stock splits are usually done to increase the liquidity of the stock (more shares outstanding) and to make it more affordable for investors to buy regular lots. For example, Share of $10 par value is divided into five shares of $2 par value which means stocksplit in 1:5. Because of stock split no. of shares outstanding increases while its par value decreases. Further there is no change in the common stock capital of the company because the total value remains same. Increase in no. of shares is offset by decrease in par value of shares.

These actions are important to stockholders because company paying dividends is always in interest of investors because they are giving returns on the value invested by shareholders while stock split will not impact the shareholders interest because this only divides a single share in multiple shares but the total value remains same and does not amount to returns on investment.