A stock dividend is a pro rata distribution of a company’s own shares to its shareholders in place of or in addition to a cash dividend and achieved by transferring a certain value from the retained earnings account to the paid-in capital accounts (i.e., the capitalization of earnings). Stock dividends usually involve the distribution of shares of the same class as that held by the shareholders (e.g., common stock to common shareholders), the amount being expressed as a percentage of the existing shares outstanding. A stock dividend is generally not taxable until the recipient sells the shares and realizes a pro rata capital gain on the sale.
After a stock dividend, a shareholder experiences no effective change in ownership position or proportionate interest, each share of that class of stock having a lower book value per share since more shares are outstanding with no increase in the value of total owners’ equity. Shareholders do not pay for these new shares and the company raises no additional capital. The shares in a stock dividend normally come from unissued authorized shares and are paid for by the company with retained earnings, which conserves the cash within the firm.
There are several reasons why a company might declare a stock dividend:
- When a firm is unwilling or unable to pay cash dividends, to appease shareholders.
- When the share’s market price rises above a desirable trading range, to reduce the per share market value.
- When retained earnings may have become large relative to total owners’ equity, to capitalize earnings.
- To increase the number of shareholders, with some of the shareholders selling their new shares.