Why is a stock dividend considered a dividend? What makes it different from a stock split?

Question

I've been reading Principles of Corporate Finance by Brealey, Myers and Allen, but unfortunately they did not cover stock dividends. From what I understand, by paying a dividend, a company can transfer value back to its shareholders. This can be done as either cash dividend (payout or repurchases) or a stock dividend.

Now how does stock dividend, which is essentially a stock split, transfer value? From what I understand, a stock dividend is the same as dividing each owned share in, say, two equal pieces and concluding "now I have two pieces that are worth halve the original, thus nothing has changed for me as an investor."

I've thought of possible reasons for a stock dividend. One reason was that by splitting shares, the value of each share decreases. This would probably improve liquidity, which might increase stock value. But I'm not really satisfied by this explanation.

Answer 1

The key difference I've found between a stock split and a stock dividend – of the exact same stock and class, as opposed to a spin-off – seems to be from the company's own accounting perspective. There doesn't appear to be any actual transfer of value to the shareholder with either kind of transaction; i.e. in theory, each transaction would be immaterial to the value of your holdings.

With respect to the company's accounting, a stock split affects the par value of the shares, whereas a stock dividend reduces the retained earnings account in order to increase paid-in or contributed capital.

I found a good online source which explains the history behind this accounting difference:
McGraw-Hill - Intermediate Accounting eBook, 6/e - Chapter 18 - Stock Dividends and Splits.
Small quote:

[...]

Besides being based on fallacious reasoning, accounting for stock dividends by artificially reclassifying “earned” capital as “invested” capital conflicts with the reporting objective of reporting shareholders' equity by source. Despite these limitations, this outdated accounting standard still applies.

REASONS FOR STOCK DIVIDENDS.

Since neither the corporation nor its shareholders apparently benefits from stock dividends, why do companies declare them?²³ Occasionally, a company tries to give shareholders the illusion that they are receiving a real dividend.

Another reason is merely to enable the corporation to take advantage of the accepted accounting practice of capitalizing retained earnings. Specifically, a company might wish to reduce an existing balance in retained earnings—otherwise available for cash dividends—so it can reinvest the earned assets represented by that balance without carrying a large balance in retained earnings.

[...]

There's a lot more on that page, before and after, worth reading.

From another book: Google Books - Comparative Income Taxation, a Structural Analysis - page 314 - Stock Dividends. Small quote:

5.6.2. Stock dividends

The distribution of dividends in the form of stock or "bonus" shares to existing shareholders typically involves a transfer for corporate law purposes of retained earnings into stated capital. It can been [sic] viewed as a deemed distribution of a cash dividend to the shareholders followed by a corresponding contribution to capital or as solely as an event at the corporate level which has no effect on the shareholders whose economic interest in the corporation is unchanged by the receipt of additional shares. The systems have taken varied approaches to the stock dividend problem. The treatment is in part a function of the rules dealing with distributions of stated capital.

[emphases above are mine]

[... continues w/descriptions of different countries' tax treatments of the kinds of stock dividends. Includes U.S., Sweden, Japan, Netherlands, Canada, Australia, U.K., France, Germany. ...]

As far as why a corporation might want to capitalize earnings and reduce the equity otherwise available for dividends, I can only imagine that, ignoring taxes for a moment, that it may have something to do with capital ratios that need to be maintained for financing or regulatory purposes? Yet, I remain curious. If I discover more on this then I'll update my answer.

Additional resources:

• Investopedia - Dividends - Stock Dividends and Stock Splits
• Accounting Coach - Stockholder's Equity (Explanation)
• The Motley Fool wiki - Stock-split - Accounting treatment

Answer 2

You can argue that cash dividend is a kind of split as well by this logic. The stock price on ex-dividend gets a hit coincidental with the dividend to be paid, so one can argue that the investor has the same cash value on the day the dividend was paid as if it wouldn't be paid at all.

However, for the company to distribute stocks instead of cash may be advantageous if they have low cash reserves but significant amount of treasury stocks, and the stocks are of high liquidity.

It is also a way for the company to release treasury stocks without diluting the current shareholders and creating taxable income to the company, that's an important factor to consider.

This is in fact the real answer to your question. The main difference between split and stock dividend is that in split, the stock distributions proportions don't change.

With stock dividend - they do. While the outstanding share proportions do not change, total proportions do, because of the treasury stocks being distributed. So company has less stocks in its vaults, but everyone else still has the same proportions of ownership. Compare this to split: company's treasury stocks would be split as well, and it would continue essentially sitting on the same proportion of stocks.

That shift of treasury stocks to the outside shareholders - this is what makes it a dividend.

Answer 3

A stock dividend isn't exactly a split.

Example:

You have 100 shares of stock worth $5 a share (total value $500). The company wants to distribute a dividend worth 1%. You could expect a check for $5. But If they wanted to do a stock dividend they could send you 0.01 shares for every share you own, in your case you will be given a single share worth $5. Now you own 101 shares.

Why a share dividend? It doesn't take cash to give the dividend. It keeps the money invested in the company. Some investors re-invest a cash dividend, some don't. A cash dividend is generally taxable income for the investor; a stock dividend isn't. Some investors prefer one over the other, but it depends on their specific financial picture.

Neither a stock dividend, a cash dividend or split changes anything. The split changes the price to meet a goal. The cash dividend lowers the price by sending excess cash to the investors. The stock dividend lowers the price by creating new shares and retaining cash.

It company picks the message and the method. depending on their goals and situation. Remember that a company may want to give a dividend because they have a history of doing so, but not have the cash to do so.

It is like a split because the number of shares you own will go up, and the price per share will go down. But a split is generally done to bring the price of a share to within a specific range. The company sees a benefit to having a stock mid priced, instead of very high or very low.

Answer 4

Stock splits and stock dividends are given different accounting treatment.

Stock splits

When there is a stock split, the par value of the stock is reduced, and the number of shares is increased. For example, after a 2-for-1 stock split on 100,000 shares of par value of $1, there will be 200,000 shares of par value $0.50.

Stock dividends

There are two primary methods used to record stock dividends:

• Par value method — The par value of shares issued is transferred from retained earnings to share capital.
• Fair value method — The market value of shares issued is transferred from retained earnings to share capital and share premium (if in excess of par value).

In other words, debit retained earnings, credit share capital and if necessary, credit share premium.

Note: "Share capital" is also known as "common stock". "Share premium" is also known as "additional paid-in capital".

Stock dividends under US GAAP

US GAAP distinguishes between small and large stock dividends. A "small" stock dividend is one that increases the number of shares by less than 20-25%.

• For small stock dividends, US GAAP uses the fair value method.
• For large stock dividends, US GAAP uses the par value method.

Stock dividends under IFRS

IFRS does not specify which method to use to account for stock dividends.

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References:

• Intermediate Accounting, IFRS Edition, 4th Edition by Kieso, Weygandt, Warfield. Chapter 15 — Equity.
• ASC 505-20-25 (Equity - Stock Dividends and Stock Splits - Recognition)
• ASC 505-20-30 (Equity - Stock Dividends and Stock Splits - Initial Measurement)

Answer 5

A stock dividend converts some of the reserves and surplus on the company's balance sheet into paid-up capital and securities premium account without involving any actual cash outflow to the shareholders. While cash dividends are eyed by the investors due to their cash yield, issuance of stock dividends are indicators of growing confidence of the management and the shareholders in the company.

The fact that shareholders want to convert free cash sitting on the balance sheet (which can ideally be taken out as dividends) into blocked money in exchange for shares is symbolic to their confidence in the company. This in turn is expected to lead to an increase in market price of the stock.