Question

In some countries, such as Australia, it is common for corporations to offer shareholder a dividend investment scheme.

(a) Discuss the advantages of a dividend reinvestment plan from the point of view of the corporation and the shareholders.

(b) Under what circumstances might such schemes prove to be unattractive to the dividend paying company.

Answer 1

A) Advantages of Dividend Reinvestment plan :-

For Corporations :-

1. Funds requirement can be fulfilled and this fund can be used elsewhere which otherwise they might to pay to the investors

2. This fund fulfills the cash requirement without increasing the debt component and thus can lead to increase in growth prospects.

3. With such plans, investors turn into long term shareholders/investors and thus this reduces the price fluctuations in the market and gives stability.

For Shareholders :-

1. Shares are offered at a discount to the market price (normally between 1 to 10 percent)

2. Power of Compounding

3. Normally, there's no commission charged on such transactions.

B) When the company is cash -rich company and there's no need for cash requirement at that time, companies wouldn't want to dilute the equity base by such plans. Normally, these plans are proposed to fulfill the cash requirement but if a company is already sitting with a large amount of cash, there's no need for such plans.

Also, these shares are traded via the company and not via the exchanges, so if the company doesn't want to go through this tedious task, they might just avoid the plan and just transfer the dividend to the shareholders.