Types of Dividends. The term dividend usually refers to cash distributions of earnings

The term dividend usually refers to cash distributions of earnings. If a

distribution is made from sources other than current or accumulated re-

tained earnings, the term distribution rather than dividend is used. How-

ever, it is acceptable to refer to a distribution from earnings as a dividend

and a distribution from capital as a liquidating dividend. Generally, any

direct payment by the corporation to the shareholders can be considered

part of dividend policy.

There are two main types of a dividend: common stock dividend and

preferred stock dividend.

Common stock pays dividends in three forms: cash, stock and prop-

erty. Let’s take a look at each one. Cash dividends are those that are paid

out in cash form. They are treated as investment income and are taxable

in the year they are paid.

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Stock dividends are dividends paid out in the form of additional stock

shares in the corporation, or shares of a subsidiary corporation. They are

usually issued in proportion to shares owned. For example, for every 100

shares of stock owned, a 4 percent stock dividend will yield four extra

shares. When the company distributes these new shares to investors, the

price of each share decreases to account for the new shares. This is a

recalculation of cost basis. It means that the stock dividends will not be

taxed when distributed. Stock dividends benefit the company by con-

serving its cash and they benefit the shareholder by increasing his/her

number of shares of the company.

Property dividends are paid with assets owned by the issuing com-

pany. Property dividends are usually paid in the form of products or ser-

vices that the corporation produces. Often the corporation, when paying

property dividends, will use securities of other companies owned by the

issuer.

Preferred stock further divides into four types: cumulative, non-cu-

mulative, participating and convertible. Cumulative preferred stock ac-

cords its owner a continuous claim to his or her dividends. Any unpaid

dividends accumulate until the corporation resumes paying them. Since

the cumulative preferred owner is entitled to all past and present divi-

dends, he or she is paid before common shareholders once payment is

resumed. If the board of directors suspends dividends, the shareholder

still has a claim on them. Non-cumulative (straight) preferred is the op-

posite of cumulative preferred: it doesn’t confer a steady claim on divi-

dends in the event of a dividend suspension. Shareholders of this type

may not be paid any missed dividends prior to payments being made to

the common shareholders.

Participating preferred shareholders receive extra dividends over

their nominal ones when the company makes an extra profit and the

board of directors declares dividends. Convertible preferred stock may

be converted to a certain number of shares of common stock. Preferred

investors who want the opportunity to share in the appreciation of the

company’s common stock may find this option attractive. Preferred

stock may carry a call provision. This means that the issuing company

can repurchase the stock from the shareholders. Though preferred stock

is usually called at par value, some call provisions actually tack on a pre-

mium. Because of the steady dividends accorded to preferred sharehold-

ers, call provisions are not usually advantageous to them, despite any

premiums. However, a corporation may use calls as a way to eliminate

dividends, thus increasing earnings for common shareholders.

When a firm declares a stock split, it increases the number of shares

outstanding. Because each share is now entitled to a smaller percent-

age of the firm’s cash flow, the stock price should fall. For example, if

the managers of a firm whose stock is selling at $90 declare a 3:1 stock

split, the price of a share of stock should fall to about $30. A stock split

strongly resembles a stock dividend except it is usually much larger.

The decision whether or not to pay a dividend rests in the hands of

the board of directors of the corporation. A dividend is distributed to

shareholders on a specific date. When a dividend has been declared, it

becomes a liability of the firm and cannot be easily rescinded by the cor-

poration. The amount of the dividend is expressed as dollars per share

(dividend per share), as a percentage of the market price (dividend

yield), or as a percentage of earnings per share (dividend payout).

Text 4

Read the text. Draw the tree-diagram of the text. Be ready to retell the text according

to the diagram.