Academic journal article Journal of Financial Management & Analysis

Rationale of Stock Dividends/bonus Shares: An Empirical Study of Private Sector Enterprises in India

Academic journal article Journal of Financial Management & Analysis

Rationale of Stock Dividends/bonus Shares: An Empirical Study of Private Sector Enterprises in India

Article excerpt


Stock dividends/Bonus shares constitute an integral part of dividend policy of a firm. The accounting aspect of stock dividends is that it transfers reserves to the share capital account, referred to as capitalization of reserves. As a result, there is just a shift from one constituent of equity funds to another, yielding no accretion to the equity shareholders. The effect on the financial statements is that stock dividends increase the number of outstanding shares without increasing any claim on assets by the shareholders. For this reason, they are, by and large, considered as 'cosmetic' corporate events.

This then raises the question: what motivates companies to issue stock dividends, when stock dividends, prima-facie, are of no benefit to the shareholders? Specific surveys in the United States have tried to find answers to why companies issue stock dividends, if stock dividends are the finer division of the cake that already belongs to the shareholders (Eisemann and Moses'; Baker and Phillips2). The objective of this research study is to capture the opinions of the Indian corporate managers about stock dividends and the motives for issuing them. The study also attempts to find the similarities and dissimilarities between the managerial perspectives of the U.S.A. and India, if any.


The question of why stock dividends/bonus shares* are issued, even if they are just finer division of the same pie, has been raised by various researchers in various countries. Two complementary approaches have been followed to learn about stock dividends. The first is how management perceives this decision (management's views) and the second is how the stock reacts in terms of returns, liquidity and volatility. Management surveys have been conducted to know the views and opinions about stock dividends and motives for issuing them.

Eisemann and Moses surveyed 39 chief finance officers of stock-dividend paying firms as well as 58 nonstock-dividend paying firms. The study concluded that the primary motive to pay stock dividends was to increase the number of shareholders, thereby, making the stock more attractive and easy to sell. Thus, the study indicated that stock dividends were issued with intent to enhance the liquidity of the stock. The study identified other motives too, namely, conserve cash and provide return to the shareholders, as the ex-stock dividend price would not fully adjust to the stock dividend ratio. The chief finance officers of stock-dividend-paying companies believed that stock dividends did carry some information content while the chief finance officers of non-stockdividend-paying companies felt otherwise.

Baker and Phillips further provided evidence about the management motives. Their study concluded that managers strongly agreed that stock dividends had a positive psychological impact on investors receiving them. Signaling hypothesis was supported the most, of the four main hypotheses they studied. The survey results of this study also reported that the main motive for issuing stock dividend was to maintain the firm's historical practice, which was in line with the study of Eisemann and Moses.

Market reaction to these decisions has been captured by studying the change in the share price and trading volume data on the announcement of the stock dividends in various countries. [Barker3; Chottiner and Young4; Woolridge5; Foster and Vickery6; Grinblatt, et al.1; McNichols and Dravid8; Masse, et al.9; Dravid10; Murray11] In India, stock dividends are studied with a perspective of its impact on the stock prices [Gupta12; Obaidullah13; Mohanty14; Kakati15; Mishra16].

Various hypotheses have been put forward to explain the rationale for issuing stock dividends. These hypotheses are not mutually exclusive; on the contrary, they are normally considered in an integral manner. These major hypotheses are summarized as follows:

* Signaling Hypothesis

* Trading Range Hypothesis

* Liquidity Hypothesis

* Tax Timing Hypothesis

* Cash Substitution Hypothesis

* Attention Hypothesis

* Retained Earning Hypothesis

* Signaling Hypothesis (Foster and Vickrey; Nichols; Woolridge17; Grinblatt, et al; Lakonishok and Lev18; McNichols and Dravid; Masse et al. …

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