University of Amsterdam
Amsterdam Business School
Factors that influence the decision of a firm to offer a
Dividend Reinvestment Plan
Student: Rosalie Turk
Student number: 6177611
Supervisor: Dr. Torsten Jochem
Abstract
Dividend reinvestment plans provide investors with the option to receive their dividends in the form of shares instead of cash. In this study, it is researched which firm characteristics influence the likelihood that businesses offer a DRIP. Data covering the period 2003-2012 is used to test various hypotheses regarding potential firm specific factors that could influence DRIP usage. Both univariate mean-difference analyses and multivariate linear probability models are used to test the hypotheses.
In the univariate analyses various findings provide evidence that DRIP firms are more financially constrained, larger in size, more illiquid and are considerably more highly leveraged. Also, the fraction of insiders in the shareholder base of firms was lower and the fraction of institutional investors noticeably higher. The findings were mixed concerning the volatility of the stock of DRIP offering businesses, their growth opportunities and profitability.
The linear probability models also provided some support that more leveraged firms, as well as businesses with a larger share of institutional shareholdings and a lower percentage of insider ownership, were more likely to offer a DRIP. These outcomes were as hypothesized. However, contrary to what was hypothesized, strong evidence was found that dividend-paying firms with more growth opportunities are less likely to offer a DRIP. Moreover, some findings show that the higher the return on assets ratio and the net profit margin of a company, the more likely the firm is to offer a DRIP. This indicates that the profitability of a firm can positively affect DRIP usage, which is opposed to what was hypothesized.
It is also shown in this study that companies are more likely to offer a DRIP during a financial crisis. The average number of DRIP offering businesses increased from 12% to 15% when comparing DRIP usage in the pre-crisis period (2003-2006) to the recent financial crisis period (2007-2009). The multivariate analyses confirmed that the likelihood that a business offers a DRIP is increased during crisis times.
Lastly, in this study also strong evidence is provided that firm characteristics can impact the likelihood that DRIP firms offer its investors specific DRIP features. The findings indicate that there is significant heterogeneity among the firms that offer DRIPs.
Table of contents
1. Introduction... 4
2. Literature Review and Economic Background………... 6
2.1 Advantages of DRIPs………....…………... 6
2.1.1 DRIPs as an equity raising mechanism……..………... 7
2.1.2 DRIPs’ ability to signal a managements’ forecasts………... 11
2.1.3 Improving shareholder relations………... 11
2.1.4 Reducing volatility……… 12
2.1.5 Broadening the shareholder base……….. 13
2.2 Disadvantages of DRIPs………...………. 13
2.2.1 Reduced market disciplining……… 14
2.2.2 Earnings per share dilution………... 15
2.2.3 Free cash flow problems ………...………...… 15
2.3 Market reaction to DRIP announcements………..……....16
2.4 Working capital management literature .. ……….………....17
2.5 Financial constraints literature……….. 19
3. Hypothesis development………....20
3.1 Hypotheses concerning the firm-characteristics of DRIP firms ……….… 21
3.2 Hypotheses concerning DRIP features….……….………. 27
4. Data collection………... 29
5. Results ………..………... 34
5.1 Summary statistics……….. 34
5.2 Univariate analysis; DRIP firms vs. non-DRIP firms………...……. 35
5.3 Univariate analysis; subsamples……… 37
5.4 Multivariate analysis; DRIP usage………..……… 40
5.5 Multivariate analysis; DRIP features……….………. 43
6. Conclusion………..……….. 46
7. Recommendations……….... 48
8. Reference list………...…………. 49
1. Introduction
With a Dividend Reinvestment Plan (DRIP), a firm provides its shareholders with the possibility to routinely reinvest their dividends in order to acquire extra shares of stock. Usually a discount is offered to participants, which implies that the shares are reinvested against a lower price than the spot rate. Moreover, transaction costs are often much lower than when stocks are purchased through a traditional broker. In addition, many firms also offer participants the option to purchase shares in excess of the dividend amount up to a specified maximum (Eckbo and Masulis, 1992). Other businesses allow the partial reinvestment of dividends and some businesses offer the direct investment option, which implies that initial shares can be bought directly from the firm instead of via a broker. These specific DRIP features make it beneficial for investors to participate in the plan and also indicate that DRIPs can offer repeated benefits to participants.
There are three different categories of DRIPs. With a new-issue DRIP, a company issues new shares or provides shares from its treasury stock. New-issue DRIPs are therefore a low-cost way for the firm to raise capital since the dividends paid to the participants do not require cash outflows and consequently these plans enable firms to retain funds (Bierman and Dubofsky, 1988). In addition, the plans offer firms access to external capital at a lower cost, because the company takes on the role of investment bank. Firms can use a DRIP in order to issue new equity periodically, thereby avoiding the traditional costs of using an investment bank to underwrite the share issue (Cherin and Hanson, 1995). Market DRIPs, on the other hand, are not used to raise capital; instead, with these plans, shares are bought on the market. Firms can also implement a combined DRIP in which shares are both purchased on the market and are newly issued.
DRIPs have been offered by firms since the 1950s and since their initiation their popularity has increased substantially (Cherin and Hanson, 1995). By 2010, more than 2000 companies offered a dividend reinvestment plan in the US (Mayo, 2010). However, the fact that not all companies offer investors the option to participate in a DRIP can imply that there are certain firm-specific characteristics that might affect whether a company chooses to offer a DRIP. The aim of the research is therefore to answer the research question:
What determines the likelihood that companies adopt Dividend Reinvestment Plans (DRIPs) and how do DRIP and non-DRIP firms differ during normal and financially distressed times?
Because it can be expected that DRIPs are an appealing instrument for businesses that experience problems with obtaining external funds, it will specifically be researched whether companies that are more financially constrained tend to implement DRIPs more often. The degree of financial constraints encountered by firms is therefore an important company characteristic that will be used in this paper with the aim of investigating whether DRIP implementation differs among certain types of companies. Most literature concerning financial constraints has concentrated on the influence of constraints on the investments made by a company and the ability of a business to save cash out of its cash flows (Fazzari et al., 1998). This paper will be a contribution to the existing literature because no research about the possible relationship between financing constraints and the implementation of dividend reinvestment plans has been performed to date.
Other firm characteristics that will be investigated are the growth opportunities of a firm, its debt level, payout ratio, liquidity, profitability, the volatility of its stock, the size of the firm and the share of institutional and insider investors. There is previous, albeit limited, research performed on how specific firm characteristics influence the decision of a company to offer a DRIP. However, to date no research about this form of payout policy has been performed concerning the recent financial crises. Moreover, in none of the existing papers a specific comparison has been made between normal times and times of financial distress. The latest financial crisis provides an especially interesting setting to study how DRIP and non-DRIP firms differ because firms' ability to access capital markets is substantially reduced during periods of financial distress. The second contribution to the literature is therefore that in this paper a sample period is used which covers both normal times and times of financial instability. Unlike the studies by Boehm and DeGennaro (2007) who investigated which types of firms adopt DRIPs for 1999 and 2004, and Mukherjee et al. (2002) who researched DRIP adoption based on data from 1983 and 1992, the sample period in this paper is from 2003 to 2012. Because this period spans the global financial crisis, it is possible to study whether differences in macroeconomic conditions affect DRIP offerings.
Furthermore, this will be the first study in which it will be specifically investigated whether the usage of specific DRIP features differs among various types of firms and when comparing normal and financially distressed times. Firms can for example try to attract a greater number of participants or try to raise a larger amount of funds by offering a discount, by offering investors the option to receive their dividends partially in shares or by enabling them to invest additional amounts through the plan.
An introduction to the research subject central in this study has now been given. The other sections of paper are arranged in the following way; in section 2, the previous literature that is related to this study will be examined. In part 3, the hypotheses that will be tested in this paper will be presented. In section 4, a description of the data gathering and the sample construction will be offered. In section 5, the empirical findings will be reviewed. In the last part of the paper, section 6, the results will be summarized and a conclusion will be given. 2. Literature Review and Economic Background
Modigliani and Miller (1961) claimed that the capital structure of a business has no impact on its overall value in perfect capital markets with symmetrical information and with no transaction costs and taxes. This implies that the dividend policy of a business is irrelevant. The dividends paid by a firm should have no impact on shareholders’ wealth because the larger the dividend the smaller is the amount the stockholders receive in the form of capital appreciation. Consequently, because dividends and capital gains can be used as perfect substitutes, stockholders who do have specific dividend preferences can use them to suit their demands. For example, investors that are in need of cash and consider the dividend payments insufficient can decide to realize some capital gains by selling stock. According to the irrelevance theorem, there is no optimal dividend policy and accordingly, the implementation of a DRIP should have no impact on the value of a business. However, in reality the restrictive assumptions of the irrelevance theorem do not hold. Because markets are in reality imperfect and not efficient, the decisions the firm takes concerning its financing can affect the value of the business. In the first section of the literature review, the main economic motives for the adoption of DRIPs will be provided. The potential disadvantages concerning the plans will be reviewed in the second section of the literature review. Various event studies have been performed to investigate the effect of a DRIP announcement on shareholders’ wealth. In the third section, the mixed outcomes of these papers will be provided and the explanations provided by the authors will be summarized. Subsequently, in the fourth section, literature concerning financial constraints will be presented. Finally, in section five, the relevant literature on the implications of the financial crisis will be provided.
2.1 Advantages of DRIPs
In the following section first the advantages associated with DRIP adoptions that have been stated in the literature concerning DRIPs will be discussed. These advantages can explain why markets can react positively to DRIP announcements. They can be broadly grouped into
agency-concerned advantages where DRIPs can be used to minimize agency problems and economic reasons where DRIPs can be used in order to save costs.
2.1.1 DRIPs as an equity raising mechanism
To finance investment opportunities businesses have the option to either use their internally generated funds or to make use of external sources such as issuing equity or debt. The pecking order theory founded by Myers and Majluf in 1984 argues that with inefficient and imperfect markets, the capital structure is important for companies and firms therefore have distinct preferences concerning their sources of financing. The theory argues that due to differences in costs between the different ways to raise equity that arise from asymmetric information between managers and shareholders, firms have the preference of financing their investments primarily with earnings which they have retained in the firm, subsequently with relatively low risk debt, then with riskier forms of debt and only as a ultimate source with external equity (Myers and Majluf, 1984).
There are various reasons why the use of external financing is costly for a business. Firms have to incur transaction costs for the equity issue and because arranging a public offering takes some time, the funds are not always readily available. However, a main disadvantage of using equity is the existence of information asymmetries. The reluctance of businesses to use equity financing predominantly stems from asymmetric information problems that exist among the people who manage a business and who invest in the firm. Because only the managers know the true condition and accurate value of a business, investors on average interpret the occurrence of an equity issue as providing negative information because they believe that managers only want to sell shares when the business is overvalued on the market. Asquith and Mullins (1986) showed that equity issues usually have a negative influence on stock prices, which can cause underpricing. This effect was further confirmed by Masulis and Korwar (1986). The price drop that occurs when the market receives the news about a new equity issue makes using this form of financing less attractive. Because the usage of leverage is considerably less affected by the private information of the managers of the business, and is predominantly influenced by interest rates, using debt is preferred over issuing equity because the level of underpricing is lower. Because no asymmetric information problems exist with the use of retained earnings, there are no transaction costs connected to them and they can immediately be used, the use of internal sources of financing is the most preferred option.
which part of earnings has to be paid out to the shareholders and which part is retained within the firm. New-issue DRIPs offer businesses a way to obtain new equity capital because the company uses shares from its treasury stock to provide the participants with new shares, and as such the firm increases its equity and is at the same time able to retain the cash it would have otherwise had to pay to the shareholders. Consequently, new-issue DRIPs can be beneficial for a company because they serve as an alternative equity raising mechanism that enables a firm to meet the dual requirements of on the one hand providing shareholders with a dividend and at on the other hand preserving earnings within the firm. The periodic additional cash received through the plan can thus lessen the need of a business for traditional external financing. According to Dubofsky and Bierman (1988), DRIPs are valuable because they can improve the capital structure of a firm because it overall becomes less risky and leveraged. Chang and Nichols (1992) also confirm that DRIPs can be valuable to reduce the dependency of a business on debt. Moreover, DRIPs can be a good resolution for firms that deal with cash shortage problems.
In the study executed by Finnerty in 1989, the influence of new-issue DRIPs on the cost of equity capital was particularly studied. Specifically, the author focused on making a comparison between the cost of capital of issuing equity through a DRIP, of traditional stock issues and the cost of retained earnings. The conclusion was that the cost of using a DRIP to raise equity was more substantial when retained earnings were used, but lower than when new shares were issued. It can thus be concluded that, especially when the availability of retained earnings is inadequate, it is beneficial for a firm to raise equity through a DRIP because it is a cheaper method of financing.
By surveying managers of Australian firms, Zammit (1995) concluded that DRIPs that offer a discount are used to make participating in the plan more appealing for investors and therefore can be used by firms to raise a larger amount of cash, which aids to preserve the preferred degree of liquidity of a firm. However, Finnerty (1989) also investigated empirically the effect of offering a DRIP discount on the cost of capital. He concluded that a discount DRIP does increase the cost of capital. Companies can thus make participating in a DRIP attractive by offering a discount; however, the size of the discount should be small enough so that the cost of raising equity through the plan remains below the cost of capital of a traditional equity issue.
Anderson (1986) concluded that the most important motive for Australian firms to introduce a DRIP was their ability to serve as a form of raising equity. Moreover, Fredman and Nichols (1982) showed that DRIPs offer a considerable amount of working capital which
has the additional advantage of being relatively unaffected by macroeconomic conditions. There is limited research about the exact amount of equity raised through DRIPs. Finnerty (1989) created a Salomon Brothers estimate for 1983 and approximated the amount raised via DRIPs for that year to be 4.6 billion USD for businesses in the US. Zammit (1995) investigated Australian equity raisings through DRIPs and estimated the amount to be 3 billion AUS per year for Australian firms.
New-issue DRIPs are not merely an alternative for raising equity. The pecking order theory can be used to provide an additional explanation why DRIPs can be useful for corporations. A main advantage of using DRIPs is that they can be used by firms who want to increase equity but wish to reduce the negative signaling consequences that would cause a decline in the share price (Dubofsky and Bierman, 1988). Various researchers such as Dhillon et al. (1992), Finnerty (1989) and Scholes and Wolfson (1989) have verified that new-issue DRIPs can be a valuable alternative to issuing new shares traditionally since the negative price signal after raising equity through a DRIP is considerably smaller as compared to a normal public offering.
The explanation for the lower negative signal is that with new-issue DRIPs, businesses raise relatively small amounts of funds incrementally over time while with a traditional capital issue a single large block of shares is issued at once (Mukherjee et al., 2002). By spreading the issue over time, the information asymmetries between shareholders and the management are reduced because the information has more time to reach the market, for example through the use of accounting disclosures (Scholes and Wolfson, 1989). In addition, stock dilution due to the increase in shares, will be more spread out over time. Moreover, whereas with a usual equity issue the management can time the issue when the stock is overvalued, this is not possible with a DRIP because the equity it is raised in regular intervals.
When businesses experience inadequate resources to finance their dividends and are consequently in need of capital they can decide to lower the dividend payout ratio. However, another implication of the pecking order theory is that dividends can be considered “sticky”. Businesses are unlikely to change their dividend policy if changes occur in the funding needs of the business (Myers, 1977). According to Lintner (1956) firms set their payout ratio while taking a long term perspective into account because they are unwilling to set a dividend payout ratio that needs to be adjusted downwards in the future. Information problems can again explain why firms that are in need of capital, are reluctant to implement dividend cuts (Lintner, 1956). Bhattacharya showed in 1979 that when a business chooses to lower their dividend payout ratio this communicates negative news about their present and future cash
flows to the market. Investors interpret the reduction negatively because it can signal that managers foresee lower future earnings and deterioration in the financial situation of the corporation. Various researchers later confirmed the negative price effect of dividend cuts (for example: Miller and Rock, 1985). By implementing a DRIP, companies can commit to their previously set dividend payout ratio while having lower cash outflows. As such, DRIPs can be beneficial for firms who are in need of cash (Baker, 2009). However, the market reaction after the implementation of a DRIP by a firm who is avoiding a dividend cut depends on how easily the market can be fooled. If market participants are able to detect the true intentions, the implementation of a DRIP could be interpreted as a signal that the management of the firm expects a less favorable financial situation. While on paper the business keeps its payout ratio steady, the same negative stock price reaction could thus potentially occur as would be the case if it had cut its dividends.
When a firm raises equity in the traditional way, direct flotation costs have to be paid to the investment bank that is used as the underwriter. These cost can be substantial, for example Carlson (1996) found that the costs of issuing new equity were between five and fifteen percent of the total amount raised. Eckbo and Masulis (1992) found a percentage of 6.09 for industrial companies and 5.53 for utility firms. The costs that are paid to the underwriter accounts for ninety percent of the total costs. Issuing equity through a DRIP can therefore be substantially cheaper because these flotation costs are avoided because the broker is bypassed. Moreover, the costs of implementing and administering a DRIP are significantly lower when compared to issuing new stocks because less dividend checks have to be processed and also less stock certificates have to be created (Chiang et al., 2004). MacQuarrie (1995) also argued that DRIP-offering businesses can save costs when they need to send proxy materials to investors. The author found that it is cheaper to distribute such information straight to the individual shareholders as opposed to sending them via their broker. Cherin and Hanson (1995) made an estimation of the usual cost savings generated by dividend reinvestment plans, and found that raising funds via a DRIP usually ranges from 2% to 3% while investment bankers typically ask a fee which is between 3% and 5%. Anderson (1986) argued that the savings in costs associated with a traditional equity issue, were a substantial aspect that induced Australian businesses to adopt a DRIP. A positive market reaction after the DRIP installment can thus also be partially explained by the reduction in brokerage fees and transaction costs which would otherwise have been incurred by the business. Moreover, Scholes and Wolfson (1989) argued that these cost savings also can explain why firms offer a discount. Instead of having to use funds to pay an underwriting
fee to an investment bank, these funds can now be used by the firm to distribute to its own shareholders who decide to participate in the plan, in the form of providing them with a discount. Thereby participation in the DRIP can be enhanced.
2.1.2 DRIPs’ ability to signal a management’s forecasts
Another advantage of DRIPs is that the plans can be used as a way to provide positive information to the market. The implementation of a new-issue DRIP results in more shares outstanding and as such also increases the size of the dividends that are due by the firm (Chan, 1993). By instituting a plan the firm should be confident that it can meet its dividend standard even if participation rates in the plan will be low. This can provide a signal to the market that the management has positive earnings forecasts for the future or has enough upcoming positive NPV projects. Namely, only in the case that the management is positive about the future earnings of the firm it is willing to make additional dividend payout commitments. The announcement of a DRIP can thus be perceived as positive by the market if investors believe that it signals positive information concerning the forthcoming earnings of the firm (Dubofsky and Bierman, 1988).
2.1.3 Improving shareholder relations
An additional advantage of DRIPs is that firms can implement them in order to improve the relationship they have with their shareholders. For investors DRIPs are beneficial because by participating in the plan they can purchase additional shares at a lower price than when purchased on the market because no broker has to be used and a discount is often offered through the plan. Consequently, reinvesting through the DRIP is therefore usually cheaper for investors than when they use the dividends to buy the shares by themselves on the stock market (Finnerty, 1989). Because shareholders can decide themselves whether or not to participate in a DRIP, the plans provide them with the possibility to tailor the payout policy of the business so that it fits their individual preferences. This facilitates the firm to attract different clienteles with distinct dividend preferences (Finnerty, 1989). DRIPs can function in this way as an instrument to generate goodwill and devotion among stockholders.
Survey research executed by Anderson in 1986 and by Zammit in 1995 among Australian firms confirmed that the improvement of the firm’s relationship with its shareholders was an important reason for businesses to implement a DRIP. Some firms also implemented a DRIP in order to make investing in the firm more attractive for the customers and employees of the company (DeGennaro, 2003). The improved brand loyalty can also be
an advantage because it can generate additional sales for the firm. According to Steinbart and Swanson (1998) the sales of the business can be boosted. The argument provided was that customers who hold stock in the company are less prone to buying from competitors.
Moreover, attracting customers to become shareholders in the firm can be beneficial because of economies-of-scope. When a customer also owns shares, it becomes easier and less expensive for the firm to approach them for other services because different forms of marketing information can be delivered together with the usual shareholder communication. DeGennaro (2003) also emphasized that it can be valuable to use DRIPs to entice employees to become shareholders. Namely, if employees are also investors in the business they have fewer incentives to shirk because when firm value is affected they also suffer the costs of their shirking behavior.
Lastly, Chiang et al. (2004) also brought forward that improving the shareholder relations can be beneficial because it lowers the possibility of an unsolicited takeover. When investors are loyal to the firm they are less prone to support a takeover attempt, for example during a proxy fight.
2.1.4 Reducing volatility
The loyalty can also be advantageous because it can preserve a stable demand for the shares of the business. A more stable demand implies less stock price volatility. However, improved loyalty is not the only reason which can explain the lower volatility due to DRIPs. Namely, Davey (1976) argues that market DRIPs can lower the volatility because the companies who offer such plans need to purchase the shares on the market which creates a solid demand for the stock. Moreover, Chiang et al. (2004) showed that DRIPs can also lower stock price volatility because the plans attract small individual investors who trade their stock less often. In many DRIP prospectuses, firms explicitly write clauses that exclude institutional investors and financial intermediaries from participating in the plan. In addition, firms can have a requirement that forces investors to have their shares registered “on record” in order to increase the fraction of retail investors in the firm1. Moreover, according to Mukherjee et al.
1 " (…) firms with company-sponsored DRIPs routinely require an individual investor to become the shareholder of record
in order to participate in their DRIP. This requirement helps to grow and stabilize retail ownership" (Berkman and Koch,
2013).
(...) by building a base of direct shareholders, a company might be less vulnerable to an institutional sell-off or to losing favor with a brokerage firm." (Baker et al., 2002)
(2002), US laws can restrict participation in the plan to only individuals. Survey findings by Davey (1976) confirm that the volatility reduction is one of the benefits that can clarify the usage of DRIPs.
2.1.5 Broadening the shareholder base
The results of the survey findings by Davey (1976) also provided evidence that businesses can implement the plans in order to broaden their share ownership, which can for example be valuable in order to protect the firm against unwanted takeovers. This was further supported by a study performed by Steinbart and Swanson (1998). They conducted a study in which they evaluated the reasons for DRIP offerings by executing telephone interviews with firm managers and by studying the prospectuses of businesses. Their main conclusion was that DRIPs can be an efficient method of broadening the shareholder base of a corporation and that this is therefore an important motive for companies to offer a DRIP. As explained in section 2.1.4, DRIP participants are generally retail/individual investors. They usually apply a buy and hold strategy and have a long-term perspective. Because they are less likely to trade their stock as compared to institutional investors, offering a DRIP can have a stabilizing influence on the stockholder base (Baker, 2009). In addition, new-issue DRIPs can raise the expenses of a takeover attempt. Namely, with new-issue DRIPs, the total amount of shares outstanding increases over time, which makes it more difficult and costly for an investor to acquire a majority position within the firm. DRIPs can therefore be valuable for businesses because the plans make it more costly for hostile investors to exploit a situation where the firm experiences a period of underperformance.
2.2 Disadvantages of DRIPs
DRIPs are not always perceived as value increasing by shareholders. In the existing academic literature various disadvantages are also outlined. In this section, the disadvantages associated with the implementation of DRIPs will therefore be discussed.
2.2.1 Reduced market disciplining
As described in section 2.1.5, DRIPs can be used as an anti-takeover mechanism. Boehm and DeGennaro (2007) use the same line of reasoning: DRIPs can also be used by businesses as a device to entrench the management because they shield the management from outside control. From the 1980s widespread shareholder activism emerged where institutional investors obtained controlling positions in firms with the objective of altering the management of the
business (Friedman, 1996). Large institutional investors have motivations to screen the management of a firm and if necessary, to try to achieve changes because such actions can potentially lead to a higher value of the firm and hence of their own investments. However, only the activists have to pay the costs associated with their actions while all shareholders benefit from the value created by the realized changes. This results in a setting where only the investors with large enough holdings can achieve returns that outweigh the costs related to their activism. Because small investors hold only a small stake in the firm, they have fewer motivations to monitor the management because they only have limited resources and time (Baker, 2009).
When the management of a business engages in suboptimal investments or consumes excessive perks this will be ultimately be discovered by the market, which causes a stock price reduction. Through the market of corporate control shareholder activists will eventually make corrections (Goshen, 1995). However, when there are a lot of institutional shareholders, businesses could reduce their control by using new-issue DRIPs to intentionally broaden the shareholder base. DRIPs may therefore reduce the disciplining effects of the market of corporate control and lower the pressure that can be executed by activist shareholders and block holders. This can be suboptimal because it generates a larger potential for the occurrence of agency problems. For example, it makes it easier for the management to entrench itself to the firm or to engage in shirking, the consumption of excessive perks or to grant itself excessive compensation.
When firms issue equity they also undergo rigorous outside monitoring by for example financiers, analysts, accounting firms and examinations by investors in security markets. This reduces information asymmetries. This process does not happen sizably with dividend reinvestment plans. Because of the lower scrutiny, the uncertainty concerning the true value of the business is higher which can result in security underpricing (Roden and Stripling, 1996).
Lastly, DRIPs are used so to bypass the underwriter which can be a disadvantage too. This is because the usage of a respected investment bank as the underwriter can be an indicator for investors of the quality of the issue. For firms it is difficult to convincingly signal their true value because of information asymmetries. Respectable underwriters however can be valuable for the firm because they can help them to more credibly signal their value and to persuade the shareholders of the accuracy of the share price. An example in which this is done is the use of road shows before an initial public offering (Booth and Smith, 1986).
Companies can thus profit from using an esteemed underwriter because it can validate their price. In the paper by Tinic (1988) it was argued that the absence of underwriter accreditation in the case of DRIP issues could result in lower stock returns and shareholder value.
2.2.2 Earnings per share dilution
Another disadvantage reported by the study by Davey (1976) is that new-issue DRIPs have the potential of diluting earnings per share because of the increase in the equity of the firm. With discount DRIPs this potential dilution effect is even more substantial (Abraham, 2012). Chan et al. (1993) provided anecdotal evidence of firms that postponed their dividend reinvestment plan or reduced the discount offered in the plan because of the earnings per share dilution that was caused by the plans.
2.2.3 Free cash flow problems
The free cash flow problem is another problem that can be aggravated by the initiation of a DRIP. New-issue DRIPs provide the management regularly with surplus cash. Jensen (1986) argued that agency problems could possibly occur if this surplus cash is invested in negative NPV projects or is used by the management for consuming corporate perks. In addition, the management can engage in empire building, which implies that they increase the size of the firm beyond its optimal level for reputational reasons or in order to increase their compensation. The shareholders have to bear the costs of the inefficient cash flow use because it lowers the value of the company. Because new-issue DRIPs generate a continuous source of additional funds for companies, the agency problems are expected to be especially large during times when few positive NPV projects are available (Saporoschenko, 1998).
2.3 Market reaction to DRIP announcements
The majority of the empirical studies concerning DRIPs consist of event studies that examine the impact on the returns of securities and the shareholder wealth implications around the dates on which a business announces the offering of a dividend reinvestment plan. The studies have been performed with both US and Australian data. However, the results of the studies are ambiguous.
Dhillon. (1992) investigated the impact of both discount and non-discount DRIP initiations on stock prices for the sample period 1976 to 1987. In their study they made a
specific comparison between industrial and utility companies. Their sample contained 71 utilities and 76 industrial businesses. They only found a significant negative reaction over a [0,1] event window for the industrial companies that initiated a DRIP without a discount. However, according to the authors these stock price reactions were considerably smaller than when compared to usual equity issues. The authors argued that these findings provide evidence that issuing equity through a DRIP is valuable because the negative stock price reaction is less substantial. For the industrial and utility firms that adopted a discount-DRIP and for the utility companies that offered a non-discount DRIP, the stock price reactions found in the study were statistically insignificant.
Roden and Stripling (1996) used a sample of 153 utility firms for the period 1971 to 1981 and found significant positive abnormal stock price effects for three intervals, namely the [-15, -1], [-10, -1] and [-5, -1] daily event windows before the announcement of a DRIP. No significant reactions were however found after the DRIP announcement. These researchers also stated in their paper that a potential explanation for these positive reactions is the capability of issuing equity via a DRIP to circumvent the common negative stock price response, which generally occurs with issuing new shares. In addition, they provided as an argument that by using a DRIP the firm does not have to pay the large fees associated with underwriting of the stock issue.
The study by Dubofsky and Bierman (1988), as cited in Scholes and Wolfson (1989), reported significant positive abnormal returns when investigating the three days around the announcements of discount DRIPs for the sample period 1975-1983. The positive stock price reactions were between !!% and !!%. However, the small sample size which was used in this study consisting of only 33 utility firms and 20 non-utility firms. The external validity is might be limited though, since a small sample size was used which might not have been fully representative for both sectors. No differences in the effects between utility and non-utility firms were found.
Perumpral et al. (1991), summarized in Saporoschenko (1998), discovered significant positive abnormal returns when investigating the month in which the DRIP was first announced by a firm. Their sample contained 160 DRIP offering businesses and the period investigated was 1968 to 1980. However, when further splitting the sample between discount and non-discount DRIPs, they found that the abnormal returns for discount DRIPs were insignificant and surprisingly for the non-discount DRIPs they were significant positive.
Peterson et al. (1987) as cited in Chan et al. (1996), investigated the SEC filings of newly issued shares through DRIPs by both utility and industrial companies. They used a sample of 48 utilities and 70 industrial firms and focused on the period 1976 to 1983. They found positive but insignificant average abnormal returns over a [0, 1] event window. In 1981, a special tax exemption of 750 dollar, on dividend reinvestment was offered to investors in utility firms in the US. This made it more advantageous for investors to participate in a DRIP because it gave them the additional tax benefits. A specific focus of the paper was therefore to make a comparison between the stock price reactions to DRIP initiations before and after this tax exemption for the subsample of utility businesses. The authors reported significant negative abnormal returns for utilities before the tax exemption, and significant positive abnormal returns in the exemption period. These results are not surprisingly because they mainly confirm that investors consider it valuable that the plan provides them with extra financial rewards.
Chang and Nichols (1992) confirm the findings concerning the effect of the implementation of the tax exemption in 1981. Just like Peterson et al. (1987) they found that utility firms that were eligible to offer participants the tax exemption experienced significant positive abnormal returns around the DRIP announcements. In addition, their research also showed that the participation rates in DRIPs of the qualifying utility firms increased after the change of the tax system.
In Australia a system in which double taxed had to be paid on dividends was abolished in 1987, and as such participating in a dividend reinvestment plan became also more advantageous for shareholders. The effect of the change to this new taxation standard, called the dividend imputation system, on the abnormal returns around DRIP announcements was investigated by Chan et al. (1993). In their event study, they found insignificant abnormal returns around DRIP announcements before the reform. However, after the reform, positive abnormal returns were found. This is not surprising because it reflects that the market responds positively on the elimination of the double dividend taxation.
Although various studies made a distinction between discount and non-discount DRIPs, the effect of the size of the discount was often not taken into consideration. If an optimal discount size would exist this would impact the magnitude of the market reactions. A later study by Chan et al. (1996) therefore focused on investigating the market reactions while considering discounts of various sizes in order to investigate the existence of an optimal discount level. The authors used Australian data and found that overall, the market responded positively to the announcement of a DRIP. However, the market reaction to various discounts
differed noticeably. Specifically, they researched DRIPs that offered 10%, 7.5% and 5% discounts for the years 1984 to 1989. They only found a significant positive stock price reaction on the announcement day for the 7.5% discount sample. The reactions for the 5% and 10% subsamples were all found insignificant. The authors provided various arguments for these results. The 5% discount DRIPs in the sample were mainly used by firms prior to the initiation of the dividend imputation regime. The 7.5% and 10% discount DRIPs were mostly offered after the tax change, which overall made DRIPs more attractive. A potential explanation for the insignificant reaction to the plans with a 10% discount provided by the authors is that this considerable large discount was not equally perceived as valuable by all investors. Namely, the large discount would imply a wealth transfer from the investors who do not participate in the plan to the ones who do. The authors stated that the 7.5% discount is likely is nearer to the optimal discount.
2.4 Working capital management literature
An important firm characteristic, which will be investigated in this study, is the degree of financial constraints of a firm. Therefore, in this section, the related literature concerning financially constrained firms will be provided. As explained by Lamont et al. (2001), a firm can be constrained in various ways. For example, it can be because of credit constraints, not being able to borrow or issue equity, a heavy reliance on bank loans or due to asset illiquidity. Financial constraints can have an important influence on the financial management of businesses. Namely, firms that are financially constrained experience frictions that restrict the business from being able to fund all preferred investment chances. Because constrained businesses are less capable of obtaining external funds at a reasonable price, they are either unable to participate in all available positive NPV projects or they need to use overly costly forms of financing which has harmful implications for firm value (Williamson, 2013). Fazzari et al. (1988) argued that the investment made by businesses therefore does not only depend on the availability of positive NPV investment projects but is also highly dependent on the amount of internal reserves held by the company.
Unconstrained companies have unhindered access to capital. Consequently, liquidity management is not essential for them because they have the necessary capital to finance potential future investments. For constrained firms on the other hand, managing their liquidity is a crucial point of concern because it is essential that the business preserves sufficient funds. Keynes (1936) argued that companies hold cash as a safeguard for unfavorable future cash flow shocks. The study performed by Opler at al. (1999) confirmed that a main reason
for holding cash is to deal with cash flow volatility. Two papers have previously investigated the relationship among the degree of financial constraints of a firm and its cash reserves. Almeida et al. (2004) were the first to find a positive relationship between the total cash holdings of a business and its level of financial constrains. Namely in their study they showed that firms that are more constrained in their capability to finance investment opportunities, save on average more cash as compared firms with fewer constrains. They hold these reserves in order to prevent the situation of lacking funds for future investment opportunities. Also Denis and Sibilkov (2009) concluded that firms that have restrains concerning their financing options have higher levels of cash because it is more difficult and more costly for them to use outside financing.
2.5 Financial crisis literature
One objective of this study is to research whether the firm characteristics of DRIP offering companies are different during the occurrence of a financial crisis as opposed to normal times. In this section, relevant literature concerning the consequences of a crisis on the financial position of businesses will be discussed.
According to Brunnermeier and Pederson (2009), liquidity co-moves with the market and can therefore suddenly dry up during a financial crisis. During a crisis financial institutions reduce their market liquidity provision by decreasing the credit they provide to firms. The recent financial crisis, which started in August 2007, therefore has had striking consequences for the liquidity positions of firms. Because financial institutes incurred large losses on their financial positions their ability and readiness to take on risk was substantially reduced. As a result, the standards for borrowing were drastically increased and that supply of credit to firms was reduced (Duchin et al., 2010). For example, the paper by Ivashina and Scharfstein (2010) provided proof that financial institutions firmly limited their provision of loans to the corporate sector in times of crisis. The reduction in the availability of external financing hampers investment when firms have insufficient internal funds (Duchin et al., 2010). This was confirmed by survey research executed by Campello et al. (2010). Namely, after surveying managers of US firms, the authors concluded that companies had to sacrifice positive NPV projects during the crisis because of binding external financing limitations. Duchin et al. (2010) found that the negative effects of the crisis were especially harmful for companies that have low levels of cash, who are very reliant on external funds or who are financially constrained. The financial crisis does not only have a negative influence on the amount of external capital available to businesses but during crisis times also the spread
between the cost of internal and external funding methods is enlarged (Bernanke, 1993). This is especially harmful for more financially constrained businesses because they already experience larger costs in obtaining external funds and they also have a greater need to use external sources because of their limited internal funds. Moreover, Campello et al. (2010) found that during a crisis, financially constrained companies implemented larger reductions in the investments and overall expenditure of the business. In addition, they used more cash, used their available credit lines to a larger extend and also sold more of their assets to obtain funds as compared to unconstrained firms.
It is very important to have sufficient levels of working capital, which incorporates cash, as a security for situations in which credit becomes more restricted. Enqvist et al. (2012) showed that working capital is of greater importance during times of distress as compared to periods with a normal economic climate. Moreover, according to Fazzari and Petersen (1993) working capital management of a business is more important when the firm is more financially constrained. Almeida and Campello (2010) confirmed this. Namely, they found that more severely constrained companies have a larger need for working capital and cash savings. Fredman and Nichols (1982) argued that DRIPs can offer a considerable contribution to the working capital of a business since the plans increase the cash holdings of the business. DRIPs can thus play a substantial role of importance in the liquidity management of a company and can ease the financial situation of firms during a crisis.
3. Hypotheses development
In this paper it will be investigated which firm-characteristics can influence the decision of a firm to offer a DRIP. In section 3.1, the firm characteristics that will be researched will be discussed. Moreover, the underlying hypotheses for investigating these specific characteristics will be described. In section 3.2, various DRIP features will be described and the hypotheses concerning the influence of firm specific factors on the usage of these features will be provided.
3.1 Hypotheses concerning the firm-characteristics of DRIP firms
The degree of financial constraints of a firm is one of the main firm characteristics on which this research will focus. One channel through which businesses can potentially ease their financial constraints is through the adoption of a DRIP. As explained in section 2.1.1 of the literature review, one of the main benefits of dividend reinvestment plans is that they can be used as an alternative for issuing equity in the traditional way. Because new-issue DRIPs
increase the cash available to the firm, they can be particularly valuable for firms that are financially constrained. Because DRIPs can function as a valuable device to alleviate financial constraints, it is hypothesized that:
H1: Firms that are more financially constrained are more likely to offer a DRIP compared to less constrained firms
The WW index created by Whited and Wu (2006) and the KZ index founded by Kaplan and Zingales (1997) are two generally accepted indices that will be used to measure how financially constrained a company is. Both indices take into account various firm characteristics that affect the level of constraints of a firm.
As explained in section 2.1.1, DRIPs cannot only be a cheap source of capital for firms but they also have less negative signaling implications on firm value than when stock is issued directly. These benefits are especially valuable for firms with a great need for obtaining funding. The usual life cycle of a company consists of a start-up phase and is followed by a stage of growth. Subsequently, the firm will enter a phase characterized by mature growth and lastly a period of decline will arrive (Baker, 2009). The dividend policy of a business typically also develops during these various stages following a common pattern. When a firm is in its startup phase generally all earnings are retained and no dividends are paid so firms also do not offer DRIPs. The payout of a dividend usually starts in the second stage. In this phase they have positive NPV investment opportunities but only limited capacity to generate the necessary capital internally (DeAngelo and DeAngelo, 2007). The dividends are usually further increased during the third stage when more earnings become available from operations, which can be paid out to the shareholders (Mukherjee et al., 2002).
Businesses that experience high growth also have high needs for funding. Both internal and external financing can be used. However, according to Higgens (1981) quickly growing companies highly depend on the usage of external financing since their internal capital is usually insufficient to finance all required investments and their capital needs are higher than the incremental cash flows of its projects. As described in section 2.1.1, using external financing usually however, has a negative influence on the share price of the company. Also, once a firm starts paying out dividends, it is generally unwilling to implement dividend cuts to finance growth because of the negative signaling effect as described in section 2.1.1, which has harmful consequences for the stock price of the company. Implementing a DRIP can therefore be valuable for firms because they can serve as a way to
finance growth with lower negative signaling consequences. Previous research executed by Mukherjee et al. (2002) confirmed that companies who go through a phase of high growth like to use DRIPs in order to retain some additional cash in order to ease future expansion.
As explained in section 2.2.3 a disadvantage of DRIPs is that they can amplify free cash flow problems. The additional cash obtained through the plan can be abused by the management. This can be a reason for firms not to implement a DRIP because the abuse of cash by the management can lower the value of the company. For high growth companies, the problem of cash flow abuse will be less prevalent because the company has plentiful investment opportunities. According to Saporoschenko (1998) this can also explain why high growth firms that pay dividends could tend to offer DRIPs more often. To conclude, when dividend-paying companies offer DRIPs, it is likely that they go through a period of rapid expansion. The hypothesis which will be tested it therefore:
H2: Firms that offer a DRIP have more growth opportunities than dividend-paying firms who do not offer the plans
Leverage however, can have a disciplinary function, which reduces the likelihood of cash flow abuse. Namely, when companies have high levels of leverage this implies that interest payments first have to be fulfilled. This reduces the cash that is available to managers, which could have potentially been used to perform actions that harm firm value. Because leverage lowers cash flow misuse, it can therefore be expected that companies are more likely to implement a DRIP when they have high levels of leverage. Moreover, according to research by Tamule et al. (1993), firms use DRIPs more often when they are close to reaching their debt capacity. When firms already have high amounts of leverage it might be difficult and costly to attract new capital because of higher risk of default. By using a DRIP, firms can reduce their dependence on external financing. As explained in section 2.1.1, DRIPs can be valuable because they make the capital structure of the company less risky. So if the DRIP implementation is driven by a firm’s need for additional funds, it is probable that these businesses have a higher degree of leverage as compared to companies who do not have DRIPs. Lastly, according to Smith and Watts (1992) companies with higher leverage are also more likely to pay dividends, which could also infer a higher probability of offering a DRIP. As such, the hypothesis that will be tested is:
businesses with low debt levels.
The size of the payout ratio will also be investigated. Companies that have a high payout ratio can be tempted to offer a DRIP in order to ease their dividend payment obligations. Namely, by offering the plan, they can sustain their payout ratio or decide to increase it further while at the same time retaining earnings. Therefore, they do not have to suffer a large deterioration in their cash flow position. It can be hypothesized that the implementation of a DRIP will be most tempting for companies that already have a high payout ratio. Firstly, this is because the larger the dividend payout ratio of a company, the larger is also the amount of funds that can be obtained through the plan. Moreover, as payout ratios increase, firms run more risk of having to cut their dividends because of cash shortages. However, firms are averse to cutting their dividends when there is deterioration in their cash flow position because of the negative effect it has on the stock price of the firm. A DRIP can help a firm to commit to its payout rate because of the additional cash retained through the plan. However, as the ambiguous event study results discussed in section 2.3 indicated, it is unsure whether the firm is truly able to fool the market or whether market participants actually understand that the initiation of a DRIP actually implies that the firm cannot pay its dividends. The hypothesis that will be tested is therefore:
H4: Firms with high dividend payout ratios are more likely to offer a DRIP as compared to firms with low payout ratios.
Another characteristic that will be investigated is the liquidity of a firm. Liquidity management is very important for a company in order to warrant that the firm has adequate amounts of cash or cash equivalents. Namely, this makes a firm better able to meet both anticipated and unanticipated financial commitments. From a long-term perspective it is necessary for companies to have enough capital reserves. According to Cherin and Hanson (1995), DRIPs can be very beneficial for companies that have liquidity problems because of the additional cash they can provide. Presumably, firms with high liquidity have, ceteris paribus, fewer motivations to implement a plan because they already have a lower probability of financial distress problems. It will therefore be tested whether:
H5: Businesses with low liquidity tend to offer a DRIP more often than firms with high liquidity
Firm characteristics which proxy the profitability of a business, will also be researched in this paper. It is plausible that firms that have low profitability are more likely to offer a DRIP in order to safeguard that still adequate capital is retained in the business. The hypothesis is consequently:
H6: Businesses with low profitability are more intended to use DRIPs then firms with high profitability
Another firm characteristic that will be investigated in this study, is the volatility of the stock of a firm. As explained in section 2.1.4 of the literature review, firms might be able to lower the volatility of their stock by offering a dividend reinvestment plan. As previously discussed, this is because plan participants are individual investors who are known to trade their stock less frequently. Moreover, market DRIPs can create a stable demand because the firm buys back shares at regular intervals. As such, the hypothesis that will be tested is:
H7: Firms with stable stock are more likely to have a DRIP in place as compared to firms with more volatile stock.
Even though the cost of raising equity via a DRIP is lower than through an underwriter, the costs of offering a DRIP can still be substantial. Besides the startup costs there are also annual maintenance expenses such as the administration, marketing and promotion of the program (Chiang et al., 2004). Early research performed by Davey in 1976 indicated that DRIP administrators usually require a fee of up to five percent of the amount of dividends reinvested by investors up to a maximum of between $1.50 and $3.00 per shareholder. A study performed by Davey in 1976, found that the financial institutions that perform the administration of dividend reinvestment plans normally charge a fee which is approximately 5% of the dividends of the amount that will be reinvested, up to a maximum which ranges between $1.50 and $3.00 per stockholder. However, in a more recent study by DeGennaro in 2003, the costs charged to DRIP offering firms were estimated to be between $12 and $16 per shareholder. The expenses associated with DRIPs are important aspects that firms take into consideration when contemplating DRIP adoption (Davey, 1976). Because the costs associated with the initiation and the continuation of the plans can be substantial in size, they can in some cases outweigh the advantages of the plan.
The implementation of DRIPs is often less expensive for large firms. This is because economies-of-scale are experienced by larger businesses (Larkin, 2005). Large firms usually have relatively lower expenses when compared to small businesses because they can use
their own internal divisions. When a firm implements a DRIP it should communicate information about the plan to its shareholders. The firm itself can create a plan prospectus or the company can use a transfer agent to establish the documentation (Berkman and Koch, 2012). Large firms have their own internal legal divisions, which can construct the DRIP information for the potential investors, while smaller companies need to consult external experts often at a higher cost. In addition, firms typically use a transfer agent for the administration of the shares distributed through a DRIP. According to Chiang et al. (2004), around 12.5% of all DRIP offering companies administer their own DRIP while 87.5% uses an agent for the administration. Large companies usually also need to use administrators for other stock-related issues. It is therefore likely that they can negotiate lower total fees, when the administrator is used for various services. According to Abraham (2012), the average cost of DRIP offerings per stockholder is therefore likely to be lower for larger sized companies.
In addition, as explained previously, in the startup phase of a company the firm generally does not pay dividends and as such will also not implement a DRIP. When a company grows bigger over time, more funds also become available to distribute to the shareholders. When a firms starts paying dividends it is likely to be larger in size and as such the possibility of offering a DRIP also becomes larger. In this study it will be especially investigated whether larger firms are more likely to offer a DRIP due to economies-of-scale. The hypothesis which is tested is therefore:
H8: Large dividend-paying firms are more likely to offer a DRIP than small dividend-paying firms.
As explained in section 2.1.5, companies can reduce the monitoring power of institutional shareholders by offering a DRIP because it broadens the shareholder base. The small individual investors attracted by offering a DRIP are less outspoken and also have fewer incentives to question the decisions made by the management or to demand changes. If the managers of a firm are concerned about preserving their own control, they aspire diffuse ownership. Broadening the shareholder base can therefore also be beneficial in order to reduce the probability of an unsolicited takeover. It can therefore be hypothesized that when firms have a shareholder base with a large fraction of institutional investors they are more likely to adopt a DRIP. The hypothesis is therefore:
H9: Firms with a relatively large share of institutional investors are more likely to offer a DRIP than firms with a small institutional investor base.
Another characteristic that is investigated in this paper is the fraction of equity held by the top management of the firm. When the management of a business owns a large proportion of the shares of the firm it has less needs to implement antitakeover provisions because it is more shielded from hostile takeover threats because it already holds high degree of control in the firm. As such it can be expected that DRIP usage is lower for such businesses. Moreover, if the management holds a large stake in the firm the initiation of a DRIP can dilute their voting power, which can make the implementation of a DRIP less desirable from the personal perspective of the management. Hence, the hypothesis that will be tested is:
H10: Firms with a relatively large fraction of insider ownership are less intended to offer a DRIP than firms with a small fraction of insider holdings.
The sample period used in this paper includes the financial crisis, which started in 2007, so that DRIP and non-DRIP firms can be investigated both in normal and financially distressed times. Because companies’ access to capital markets is reduced in times of financial distress and liquidity dries up, the additional cash provided by a DRIP can be especially useful for firms. As explained in section 2.1.5 shareholders who take part in a DRIP are usually have a considerably more long term investment perspective and generally apply a buy and hold strategy. Even though investors can change their DRIP participation at any time, participation rates in DRIPs are relatively stable and investors are not very likely to change their participation in the plan when there are changes in macroeconomic conditions. As a result, a DRIP plan can provide a firm with recurring cash inflows that are reasonably steady (Saporoschenko, 1998). Because DRIPs offer an alternative way of obtaining funds, which is especially valuable during a crisis when obtaining funds is more challenging, it can therefore be hypothesized that:
H11: Firms are more likely to offer a DRIP during a financial crisis 3.2 Hypotheses concerning DRIP features
In this study it will also be specifically researched how the features of dividend reinvestment plans differ among various types of companies and when comparing normal to financially distressed times. The different DRIP features will first be discussed and the main hypotheses will be described.
There are various features that firms can provide in order to make participating in the plan more attractive to shareholders. The most important one is the discount, which enable investors to buy shares at a lower price than the market share price. According to research by Chiang et al. (2004), discounts usually range from 1 to 10 percent. However, the most commonly used discounts are 3 and 5 percent.
Another feature is the “partial reinvestment option”. With a traditional DRIP, the full amount of the dividend paid to the shareholders is reinvested in the company’s stock. However, with the partial reinvestment option, participants can partially reinvest their dividends in shares while receiving the other dividend part in cash.
Another feature, which can increase the attractiveness of DRIPs, is the “cash option”, which enables shareholders to invest additional amounts in order to purchase more shares. How frequently the additional investments are invested differs per plan. They differ from very often, from daily reinvestments to only once a year. According to Chiang et al. (2004) the amounts range from $50 to $150.000. Various firm prospectuses indicate that this cash option program may also give a benefit throughout the year outside of dividend events. For example, the firm Heward Packard paid quaterly dividends but allowed monthly additional cash investments.2 For investors using the cash option can be advantageous because the shares can usually be bought at a lower price compared to the market. The company is able to demand a lower price because of the cost savings as explained in section 2.1.1. Another advantage for investors is that decision to invest is made each period, so there is no long-term commitment necessary. The firm usually ties both a minimum and a maximum to the investment. But because the maximum amounts allowed to invest additionally are often large (American Association of Individual investors, 2000) this cash option provides a low-cost method for investors to increase their shareholdings in the firm.
Traditional dividend reinvestment plans are only offered to existing shareholders of the firm. So at least one share should be owned in order for an investor to be able to participate in the plan. However, some companies also offer a “Direct Investment option”. This implies that investors can buy initial shares directly from the company instead of having to buy them through a broker. Again, this option can be valuable for investors because of the usually lower share price because no broker fees have to be paid. After taking part in such a Direct Investment Plan, the investors can increase their shareholdings by buying additional
2HP dividend/ reinvestment stock purchase plan,
http://media.corporate-ir.net/media_files/irol/71/71087/pdf/DRP_brochure_9_22_06.pdf
