If a firm decides to parcel out dividends to shareholders, they have a choice in the form of payment: cash or stock. Cash dividends are those paid out in currency, usually via electronic funds transfer or by paper check. This is the most common method of sharing corporate profits with the shareholders of a company. Stock or scrip dividends are those paid out in the form of additional stock shares of either the issuing corporation or another corporation.Cash dividends provide investors with a regular stream of income. Stock dividends, unlike cash dividends, do not provide liquidity to the investors; however, they do ensure capital gains to the stockholders. Therefore, if investors are not interested in a long-term investment, they will prefer regular cash payments over payments of additional stock.
Income from Dividends
When choosing between cash or stock dividends, the trade-off is between liquidity in the short-term or income from capital gains in the long-term.
Costs of taxes can also play a role in choosing between cash or stock dividends. Cash dividends are immediately taxable under most countries' tax codes as income, while stock dividends are not taxable until sold for capital gains (if stock was the only choice for receiving dividends). This can be seen as a huge benefit of stock dividends, particularly for investors of a high income tax bracket. A further benefit of the stock dividend is its perceived flexibility. Shareholders have the choice of either keeping their shares in hopes of high capital gains, or selling some of the new shares for cash, which is somewhat like receiving a cash dividend.
If the payment of stock dividends involves the issuing of new shares, it increases the total number of shares while lowering the price of each share without changing the market capitalization of the shares held. It has the same effect as a stock split: the total value of the firm is not affected. If the payment involves the issuing of new shares, it increases the total number of shares while lowering the price of each share without changing the market capitalization, or total value, of the shares held. As such, receiving stock dividends does not increase a shareholder's stake in the firm; by contrast, a shareholder receiving cash dividends could use that income to reinvest in the firm and increase their stake.
For the firm, dividend policy directly relates to the capital structure of the firm, so choosing between stock dividends and cash dividends is an important consideration. A firm that is still in its stages of growth will most likely prefer to retain its earnings and put them toward firm development, instead of sending them to their shareholders. The firm could also choose to appease investors with stock dividends, which would still allow it to retain its earnings. Conversely, a firm that is already quite stable with low growth is much more likely to choose payment of dividends in cash. The needs and cash flow of the firm are necessary points of consideration in choosing a dividend policy.