Stock Distributions: Splits and Dividends

Discussion

Because many proposals to increase authorized common shares are tied directly to the implementation of planned stock distribution, it is worth commenting on the relative merits of stock splits, stock dividends, and reverse stock splits. Shareholders can effectively cancel a split or dividend if the company does not have sufficient shares to implement a split without an increase in authorized shares. They are also entitled by exchange regulations and state law to vote on reverse splits in which multiple shares are exchanged for fewer shares.

Administrative Aspects of Stock Splits

From a legal or accounting perspective, stock distributions are mere paper transactions and are accorded little value. Indeed, there are segments of the investment community, including many institutional shareholders, that question the value of stock distributions. If there are no clear benefits from these distributions, then they are merely expensive transactions that waste shareholder resources. In fact, some institutional investors may eliminate frequently splitting stocks from their portfolios because of the administrative costs of receiving additional shares.

Recent surveys of corporate management reveal that the most frequently cited reason for stock distributions is to attain an optimal trading range (a lower trading price in the case of splits and dividends; a higher trading price in the case of reverse splits), which will lead to an increase in the number of shareholders.[1] The advantages of increasing a company's ownership base include a potential increase in trading volume. By attracting small investors, this in turn may have a long-term positive impact on share price. Distributions may also be seen as a takeover defense which will make it more difficult for an outsider to accomplish a takeover through open market stock purchases. Some managers believe that increasing the number of shareholders can improve the prospects for future rights offerings.[2]

Impact of Stock Splits

The evidence on market response to stock splits and dividends is inconclusive. Splits may signal good news in the form of increases in post-split dividends or higher earnings growth. However, splits or dividends may be bad news if they reflect a cash shortage. If a company's distributions are made regularly, their impact may be neutral. There is also evidence that stock volatility increases after a split. What is clear from research of management motivations is that stock distributions are not a meaningless bookkeeping exercise. Managers plan distributions with various financing objectives. While shareholders with different investment objectives and portfolio sizes-and different opinions regarding the value of splits and distributions-may wish to follow their own guidelines with respect to distributions, management initiatives to improve its ability to obtain future financing on attractive terms should generally be supported. Therefore, ISS recommends voting in favor of splits.