Scrip dividend is the practice of offering shareholders the option to receive shares in lieu of cash when companies make a distribution. In the UK, the popularity of this option has grown significantly in recent years. The total number of companies that offered the scrip dividend option rose from 67 in 1987 to 202 in 1992, an average increase of more than 20 percent a year. While other forms of dividend distributions, such as cash dividends and share repurchases, are mandatory and involve cash outflows, scrip dividend payment does not affect the firm’s cash position and it is offered as an option whereby shareholders are able to choose between receiving dividends in cash or their equivalent in the form of shares.
The method of paying scrip dividends in the United Kingdom is different from the way stock dividends and/or dividend reinvestment plans are offered in other countries. For example, unlike stock dividends offered in the USA, where the recipient shareholder is not taxed and does not generally have an opportunity to opt for cash (e.g. McNichols and Dravid, 1990), scrip dividends entitle the shareholder to choose between the offered share (the scrip) and the cash and both these alternatives are taxed at the personal income tax rate. Moreover, the scrip dividend option is different from dividend reinvestment plans adopted by many companies in Australia where the newly issues shares are normally at a discount of 5-10 percent (e.g. Chan et al., 1993). With scrip dividends companies are capitalizing part of their distributable profits in order to issue new shares without any discount offered.
Scrip dividends are a cheaper means of acquiring shares because shareholders are not charged brokerage fees, commission or any other costs for the allotment of shares. They also provide issuing firms with an ideal opportunity to reta in cash without altering their dividend payout policies to meet fixed charges in particular in the period of severe recession. Moreover, given that scrip dividends allow a firm to retain cash, they reduce the cash shortage problem (e.g. Eisemann and Moses, 1978).
Under the classical system of corporation tax where the taxation of dividends at the firm level and in the hands of shareholders is not linked, scrip dividends, like stock dividends in the USA, are a cosmetic financial manipulation with no effect on the firm and its shareholders (e.g. Lakonishok and Lev, 1987). On the other hand, in an imputation system such as the one in operation in the UK, scrip dividends allow firms to save in taxes because, unlike cash dividends, scrip dividends are not subject to the advanced corporation tax. Firms can thus retain cash and avoid potential tax loss. Howe ver, the firms’ tax savings are not likely to be shared by all shareholders because the tax credit on scrip dividends can only be claimed by tax-paying investors. Tax-exempt investors forgo the tax credit when they opt for scrip dividends and, as a result, their after-tax return from scrip dividends is likely to be lower than that on cash dividends. Therefore, tax-exemp t investors will prefer cash rather than scrip dividends and shareholders whose cash dividend income is taxed at a higher rate than capital gains will prefer scrip dividends for which the firm will issue additional shares. Given that tax-exempt investors are the largest group in the London Stock Exchange the take-up rate of the scrip in the UK amounts to an average of 4 percent. To increase the take-up rate, a number of companies have offered recently an enhanced scrip dividends where the notional dividend used to compute the number of share s offered is higher than cash dividend by up to 50 percent.
Empirically, Lasfer (1995) showed that firm’s decision to issue scrip dividend is not motivated by taxes, cash shortage, or signaling. Instead, managers appear to retain cash through scrip dividends to maximize their own utility.
