Elective Stock Dividends

The elective stock (or scrip) dividend gives investors the choice between receiving shares as a dividend or receiving the equivalent value in cash. If an investor opts for the former, their equity stake is not diluted but they forego the cash. If the investor opts for the cash dividend, the investor faces some dilution of their share stake in the company. Financial constraints are the most likely reason why firms offer an elective stock dividend: Firms turn to this payout channel to preserve cash. This is especially important when a firm’s cash holdings and free cash flow are low, when the firm is highly leveraged, when access to bank debt and capital markets is limited and hence the cost of capital is high, or when a firm faces high debt repayments in the near future and intends to make large investments (e.g., when the acquisition value of a target firm exceeds the retained earnings). Cash preservation is indeed the most important corporate incentive to use elective stock dividends because they tend to be offered in combination with dividend cuts. This also hints at the possibility that firms are offering an elective stock dividend to camouflage (partial) dividend omissions. Dividend reductions would be received negatively by the shareholders, but they may not fully comprehend the cut if this were presented in combination with the complexity of an elective stock dividend.