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I know that the price of a stock on the ex dividend is supposed to drop by the amount of the dividend. What i don't understand fully is why it happens. I have seen many answers/articles/books etc that parrot multiple ideas that don't make sense with reality. For example many answers even on this site say that the price drops because cash is going out the company, therefore it is worth less, etc.

Many of these reasons don't make sense because the reality is that the price of a stock on ex-dividend DOES NOT drop by the dividend when it opens at 930AM EST. it drops by the dividend amount at open during the PRE-MARKET.

In other words, it is NOT people buying and selling the stock that makes it drop by the dividend amount. There seems to be something else that causes this change.

I have seen some articles that point to the fact that the stock exchanges themselves arbitrarily SET the price of a stock to be lower, but not many places talk about this more in detail.

It's not individuals buying and selling based on some perceived sense the company is worth less, because that would happen when the stock starts trading at normal times, since that is when you need to hold the stock to even get the dividend. if people really sell their shares on ex-dividend date before market opens, they won't get the dividend. So that doesn't make sense.

So what REALLY causes the price stock to drop? Is it the stock exchanges/market makers that set the price to start lower for the day to prevent people from making free money from the dividends? this question is specific to the US stock exchanges though i would be interested in knowing if this happens in others around the world as well

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  • are you sure it doesn't drop because people want to trade it less? and some exchanges automatically drop the prices of open orders, on the assumption that's what the trader wanted anyway
    – user253751
    Aug 26 at 15:31
  • i had a stock recently that closed around 47.80 at after market hours with a dividend of 4.50. the next day on ex-dividend date, when it opened in pre-market it opened at 43.30. so no, it doesn't seem to be from people buying and selling. after that it dropped further, so that is due to people buying and selling, but the opeining at 43.30 seems to have been done by the exchange itself manually setting it at that price
    – gio13
    Aug 26 at 15:38
  • How is the pre-market opening price determined? If it's normally equal to the previous day's after-market closing price, then yes, the exchange probably adjusted it (because it assumes that traders were going to adjust it anyway). If it's based on bids and asks, then it may come from traders directly.
    – user253751
    Aug 26 at 15:40
  • @user253751 Trades during pre-market, including the first (opening) trade, are actual prices based on bids and asks. A "price" that is mathematically computed with the drop would be an "adjusted previous close" quoted for convenience. This will not generally be equal or particularly close to the actual pre-market open, because of overnight developments in news and sentiment, just as on any other (non-ex-dividend) morning. This makes the difference from "adjusted previous close" a good indication of the daily total return and the real change in the market's valuation of the stock.
    – nanoman
    Aug 26 at 18:00
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    "if people really sell their shares on ex-dividend date before market opens, they won't get the dividend" -- this is wrong. Anyone who owns shares as of the night before ex-dividend day will get the dividend, even if they sell at the 4am pre-market open. Starting that day (including pre-market), the stock is trading ex-dividend, meaning the dividend goes to the seller, not the buyer.
    – nanoman
    Aug 26 at 19:44

2 Answers 2

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A dividend does not create any value, it just transfers it. The value of the company (and hence its ownership shares) must drop to reflect the cash that's paid by the dividend.

Suppose there was a company whose only asset was $100 cash and it had 1 share of stock. That share would be worth $100. If that company paid the shareholder a $5 dividend, what are the assets of the company now? Id would have $95 in cash, so its share would be worth $95. The "owner" of the company goes from having one share worth $100 to a share worth $95 and $5 in cash. No wealth is created, only transferred.

Exactly when that happens is not relevant to why it happens. At some time around the ex-div day, the shareholders transition from owning a $100 share to a $95 share and the right to $5 cash. IF you bought a share instantly before that time, you'd pay $100 and be entitled to the dividend. If you bought it immediately after, you'd pay $95 and not be entitled to the dividend. Either way you're have $95 worth of stock after the dividend clears.

The exchanges and brokers will adjust limit and stop orders (which determine the bid/ask) so that buyers don't inadvertently pay $100 after the dividend is paid. It's possible that a buyer could put in a new limit order immediately after the ex-div date for the pre-div price, but I do not know how common that is or if there any safeguards or warnings to prevent it.

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  • "At some time around the ex-dividend day" -- it's simply the overnight before ex-dividend -- 8 hours between after-hours and pre-market when no trading occurs. The change doesn't happen during live trading. "The exchanges and brokers will adjust limit and stop orders (which determine the bid/ask)" -- there could be orders left standing overnight, which are adjusted, but they are unlikely to be the top of the order book (the bid/ask). The bid/ask changes very frequently during trading and so is normally a fresh order, not an hours-old one. ...
    – nanoman
    Aug 26 at 19:17
  • ... Shortly before the open (whether pre-market or regular hours), exchanges follow a special procedure to gather new limit orders so the opening bid/ask is fresh. Even without a dividend, it's common for a stock to open >1% (up or down) from the previous close due to new developments. "put in a new limit order immediately after the ex-div date for the pre-div price" -- that's treated just like any buy limit order that's marketable (at or above current ask) -- it executes at the ask, or possibly at higher prices if it exhausts the ask quantity.
    – nanoman
    Aug 26 at 19:23
  • this answer is wrong. please see the top answer in this link for the actual reason. all of this talk about how much a company is worth is nice theoretically, but in the real world it works differently. money.stackexchange.com/questions/110554/…
    – gio13
    Aug 29 at 17:40
  • @gio13 Can you describe specifically why that answer contradicts mine? It starts with two possible reasons but then goes on to say why the first reason is incorrect (and the second reason aligns with mine), so I don't see the contradiction.
    – D Stanley
    Aug 29 at 18:34
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    @gio13 By "top answer" at the link do you mean accepted or most upvoted? There are answers (including mine) that have more upvotes (4) and disagree with the accepted one (3).
    – nanoman
    Aug 31 at 3:39
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Company is REALLY worth less on ex-dividend day than was the day before. It is just that simple. If something pays out $100 from its assets, it is $100 worth less.

It does not matter if the stock is traded on an exchange during the premarket period. When you buy premarket on ex-dividend day, you still do not have rights to get the dividend. So naturally, you would like to pay less than the day before.

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  • this answer is wrong. please see the top answer in this link for the actual reason.money.stackexchange.com/questions/110554/…
    – gio13
    Aug 29 at 17:41
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    No, this answer is right. Company is worth less, also during premarket. What is more, the argument from the answer you provided about MOC seems to be off-base. With no ex-dividend adjustment by exchange you would not want to buy MOC because the price would be too high (not too low). Anyway, price adjustment or not, would not create arbitrage. You would not get other side of the trade. This is essence of auction type markets. Exchange can make adjustment or not, the result would be the same.
    – ePortfel
    Aug 29 at 19:43

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