HOW DOES SCRIP DIVIDEND WORK? (Process and Explanation)

The companies issue their shares to the general public who can buy them to become the company’s shareholders.

These shareholders are considered owners of the company for the fraction of shares they hold compared to the total shares issued by the company.

For their investment, the shareholders get returns in many forms. The companies’ shareholders may get the returns in any form such as dividends or capital gains.

Dividends are a share of a company’s total earnings for a period given to the shareholders. These dividends are declared and then distributed among the shareholders of the company based on their percentage of shareholding in the company.

These dividends may be paid in the form of cash. However, sometimes, the company may also give its shareholders an alternative form of dividend known as scrip dividends.

Scrip Dividend:

A scrip dividend is given by the company, in the form of a certificate, to its shareholders. This certificate gives the shareholders an option to avail of a dividend at a future point in time or receives additional shares in the form of dividends.

This means the company pays its shareholders additional shares instead of cash dividends. However, the choice to avail of the option ultimately lies with the shareholders.

The company uses scrip dividends to save cash. Scrip dividends may be given during circumstances when the company doesn’t have enough cash resources to pay cash dividends to its shareholders.

However, companies may also use scrip dividends when they need to maintain their cash reserves in case of a future need.

This cash can be used in future projects or to maintain a good balance sheet position for the company. In some cases, scrip dividends can also save taxes for the company.

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However, the company offering scrip dividends must be cautious of any negative signals the scrip dividends may spread about the company.

For example, if a company relies only on scrip dividends in every period, the shareholders or potential investors may think that the company cannot manage its cash resources properly.

Therefore, the company must only use scrip dividends in special circumstances to avoid these negative effects.

With scrip dividends, even though the shareholders aren’t paid in cash, they are still paid in shares. Shareholders can sell these shares to gain capital on the shares they never paid for.

However, since the shareholders can choose whether to avail of scrip dividends, they may choose not to avail of the option and receive cash dividends instead.

Scrip dividends also allow shareholders to increase their shareholding in the company without having to pay additional costs to acquire such shares as stamp duty, broker’s commission, etc.

Process of Scrip Dividend

The process of giving shareholders a scrip dividend is straightforward. The process begins with the company’s board of directors’ decision to pay scrip dividends. This decision may be due to several reasons discussed above.

A proposal is prepared and presented by the board of directors to the shareholders in the company’s annual general meeting.

In the annual general meeting, the shareholders may choose to approve or reject the proposal.

They may also propose changes to the proposal of the board of directors. Once approved, the record date for scrip dividends is finalized in the annual general meeting.

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The scrip dividends are presented to the company’s shareholders on the record date. These are shareholders that own shares of the company at the record date.

At this point, the company will finalize a reference price for the shares. Once a reference price is established, the shares will be issued to the company’s shareholders that have accepted the option to receive the scrip dividend shares.

Scrip dividends are issued to the shareholders based on their existing holding of shares of the company.

For example, the company may issue 1 scrip dividend share for every 5 shares held by the shareholders of the company.

So, if a shareholder owns 1,000 shares of the company, they will receive 200 (1,000 x 1 / 5) shares of the company as scrip dividends.

Conclusion

Scrip dividends are options given to the shareholders of a company to receive their dividends in the form of additional shares instead of cash dividends.

The shareholders of the company can either accept or reject the option. Scrip dividends are given to the shareholders when the company is short on cash or does not want to pay cash dividends.

However, the company must be aware of any negative signals associated with paying scrip dividends.

For shareholders, scrip dividends allow them to increase their shareholding in the company without paying additional transaction costs.