What is a Scrip Dividend: Advantages and Disadvantages
Companies provide scrip dividends or liability dividends to their shareholders in the form of a certificate instead of cash dividends. It enables shareholders to obtain dividends at a later stage or simply take shares instead of dividends. Typically, companies issue a scrip dividend when they do not have sufficient cash to pay as dividends.
Go through the following sections to know how scrip dividends work, and their advantages and disadvantages.
How do Scrip Dividends Work?
As mentioned above, a scrip dividend is an alternative to a cash dividend. Specifically, a company pays one new share for a specific quantum of shares already held. For instance, suppose a company issues 1 new share for every 10 shares. In this scenario, it is a 1 for 10 scrip dividend.
Let us understand the working of scrip dividends with another example:
Suppose XYZ Company’s share price is Rs. 100. This company pays Rs. 30 each year as dividends. Now, let’s say you own 100 shares in this company. If XYZ Company has a scrip dividend programme, you can choose to get:
- Rs. 30 X 100 = Rs. 3,000 in cash, or
- 3,000/100 = 30 additional shares
Scrip dividends are a secondary issue and a method for a company to capitalise on financial reserves.
Furthermore, in a scrip dividend, a company provides promissory notes to the shareholders. It also features a shorter maturity period and might not bear interest.
How do Companies Issue Scrip Dividends?
The process through which companies issue scrip dividends is given below:
- Step 1: At first, the board of directors propose a scrip dividend.
- Step 2: A shareholder will then approve the proposed dividend in an annual general meeting. Shareholders can also modify the dividend proposal given by the board of directors.
- Step 3: The company will finalise the AGM record date.
- Step 4: After this, the company finalises the reference price. This is typically a 5 day average of the stock’s closing price from the ex-dividend date.
- Step 5: The company will then issue these shares to its shareholders as per this formula:
Number of shares held on the date x Cash dividend per share / Reference price of share
A company issues scrip dividends to those shareholders holding shares on the record date or whose name exists in the firm’s share register.
Note that a scrip dividend is not taxable at the time of receipt like cash dividends. However, it will be taxable during the sale as capital gains. This is generally lower than the applicable tax on dividend income.
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What are the Benefits of Scrip Dividends?
A few advantages of a scrip dividend are as follows:
- The company can use additional cash for capital investment as it does not have to pay immediate cash if shareholders opt for taking shares instead.
- Shareholders can maximise their shareholding without paying extra transaction costs.
- It increases a company’s total share capital.
- Shareholders become eligible to obtain tax benefits.
- The share remains somewhat unaffected in case of share dividend issue.
- A scrip dividend also provides extra time for the company, which is typically the difference between the payment date and dividend declaration date.
What are the Disadvantages of Scrip Dividends?
Scrip dividends also feature a few drawbacks. They are as follows:
- It does not bode well for a company as stakeholders and investors might think that it suffers from cash flow issues.
- If the share price increases, the company will have to pay an increased dividend compared to the declared dividend.
- After the issuance of scrip dividends, the EPS and share price decrease. This limits the growth of shareholders’ wealth.
Final Word
A company issues a scrip dividend when it does not have sufficient cash to issue cash dividends. It helps in capital investment towards business growth or any other purpose. At the same time, scrip dividends impose a pessimistic vision with regard to a company’s financials.
FAQs
In the case of a scrip dividend, a shareholder can receive dividends in the form of additional shares or cash. There is no such provision for stock dividends. In the case of stock dividends, shareholders only received additional shares.
There are six types of dividends in total. The preferable type is a cash dividend. Apart from that, other types of dividends include stock dividend, property dividend, scrip dividend, liquidating dividend and special dividend.
Most firms prefer to pay dividends in the form of cash. Typically, this income is provided electronically or through the issuance of a cheque. Meanwhile, a few other companies may prefer rewarding their shareholders with investment securities, physical assets and real estate.
A company pays special dividends outside its regular dividend policy. It is typically paid when companies make extra profit from a specific event, such as an asset sale. Special dividends are also known as extra dividends. They feature higher payments than normal dividends.
Investors choose scrip dividends to enjoy compounding effects. Compounding is a way to generate more return on investments. Scrip dividends are a great way through which investors can compound their investments at lower costs.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
