Why Do Companies Pay Stock Dividends? The Case of Bonus Distributions in an Inflationary Environment

Abstract

We assess the market valuation of an unusual form of stock dividends, referred to as bonus distributions, which are carried out by transferring the accumulated equity reserves, mainly the inflation revaluation equity reserves, to paid-in capital leaving the total equity unchanged. In the absence of cash substitution and transaction cost effects, we find positive excess returns on the announcement dates, particularly for the financially weak firms, such as the non-cash-dividend-paying firms. We relate our results to the 'paid-in capital hypothesis' under which firms opt for bonus distributions to mitigate the impact of inflation on their eroding paid-in capital, to reduce their leverage defined as debt-to-paid-in-capital ratio, and to increase their credibility and borrowing capacity in a market of limited access to external equity financing. Although our results are also consistent with the retained earnings and signaling hypotheses, we find no support for the attention-getting, and a weak support for the liquidity enhancement hypotheses observed in other markets.

An Empirical Study on Market Reaction around the Bonus Issues Announcements in Bangladesh

“…For example, Adaoglu and Lasfer (2011) studied the market valuation of stock dividends which were funded by the revaluations of reserves in an inflationary environment and found positive abnormal return on the declaration day for these stock dividends in Turkey.…”

Frequency and Motives for Stock Dividends in a Unique Environment

“…Kunz and Rosa‐Majhensek () demonstrate that Swiss companies are using stock distributions to send positive signals to the stock market, which is consistent with the signaling hypothesis. Adaoglu and Lasfer () document some evidence that the market reaction is higher for firms that underperformed in the previous 6 months before the announcement. Their results imply that firms announce stock dividends to signal future recovery.…”

“…Stock dividends are a puzzling corporate behavior. In theory, stock distributions either by stock dividends or by stock splits are cosmetic operations aimed at dividing the corporate pie into more pieces with no change in the total firm value (Adaoglu and Lasfer 2011). However, numerous empirical studies report a significant positive market reaction to stock dividends.…”

“…For a recent literature review on this topic, see Bechmann and Raaballe (), Adaoglu and Lasfer (), Al‐Yahyaee (), and Nguyen and Wang ().…”

“…Many previous studies use the SDF as an indicator of the size of stock dividends including Adaoglu and Lasfer (), Al‐Yahyaee (), and Nguyen and Wang (), among others.…”