Question

Sometimes, rather than paying out cash dividends to stockholders, companies will issue either a stock dividend or a stock split Required: • What is the purpose of a stock dividend or stock split? • How does a stock split impact a company's financial statements? • How does a stock split impact a stockholders' individual investment? • What is a reverse stock split? (this is not covered directly in the chapter, do some online research)

Answer 1

1) Stock dividends refers to distribution of firm's profits to its shareholders by way of additional shares of the firm instead of distributing in terms of cash. Stock split refers to splitting number of outstanding shares into more number of outstanding shares and as a result, par value per share before stock-split will be decreased after stock-split. Main purpose of declaring stock dividend is to satisfy shareholders by way of shares incentives when firm doesn't have cash on hand to pay dividends actually. Similarly, main purpose of declaring stock split is to satisfy shareholders by way of increased number of outstanding shares but without extra cash so that when firm declares cash dividends in future, shareholders will receive more dividends. 2) By principle, stock-split doesn't have any impact on figures reported on financial statements as it will just increase outstanding number of shares held by current shareholders only. Number of outstanding shares reported on financial statements will increase due to stock-split though paid-in-capital doesn't get affected because of stock-split. 3) By principle, stock-split doesn't have any impact on stockholders' individual investments also as it will just increase outstanding number of shares held by current shareholders only. Number of outstanding shares held by shareholders before stock-split will increase after stock-split though investment doesn't get affected because of stock-split. For example, when 4-for-1 stock split was done, 4 shares would be issued for every 1 existing share. As a result, stock price will be reduced to 1/4th after the stock-split.

4) Reverse stock-split is opposite to stock-split whereby number of shares outstanding before reverse stock split will be decreased after reverse stock-split. For example, when 1-for-4 reverse stock split was done, 1 share would be issued for every 4 existing shares. As a result, stock price will be increased by 4 times after the reverse stock-split.