00/1.05), or $1.90. The total value of your holdings then would be

$38.10 X 105, or $4,000. Under these conditions, the stock dividend does not represent a thing of value to you. You merely have an additional stock certificate evidencing ownership. In theory, the stock dividend or split is purely cosmetic.

To the extent that the investor wishes to sell a few shares of stock for income, the stock dividend may make it easier to do so. Without the stock dividend, of course, stockholders could also sell a few shares of their original holdings for income.

In either case, the sale of stock represents the sale of principal and is subject to the capital gains tax. Some investors, however, may not look on the sale of a stock dividend as a sale of principal. To them, the stock dividend represents a windfall gain; they can sell it and still retain their original holdings. The stock dividend may have a favorable behavioral effect on these stockholders. In efficient markets, however, we would not expect a favorable impact on share price.

Effect on Cash Dividends The stock dividend or stock split may be accompanied by an increased cash dividend. For the former, suppose an investor owns 100 shares of a company paying a $1 dividend. The company declares a 10 percent stock dividend and, at the same time, announces that the cash dividend per share will remain unchanged. The investor then will have 110 shares, and total cash dividends will be $110 rather than $100, as before. In this case, a stock dividend increases the total cash dividends. Whether this increase in cash dividend has a positive effect on shareholder wealth will depend on the valuation of dividends, which we discussed earlier. Clearly, the stock dividend in this case represents a decision by the firm to increase modestly the amount of cash dividends. However, it does not need the stock dividend to do so.

Sometimes a stock dividend is employed to conserve cash. Instead of increasing the cash dividend as earnings rise, a company may desire to retain a greater portion of its earnings and declare a modest stock dividend. The decision then is to lower the dividend-payout ratio, for as earnings rise and total cash dividends remain approximately the same, the payout ratio will decline. Whether shareholder wealth is increased by this action will depend on considerations taken up in an earlier section. The decision to retain a higher proportion of earnings, of course, could be accomplished without a stock dividend. However, the stock dividend may tend to please certain investors by virtue of its psychological impact.

But the substitution of stock for cash dividends involves a sizable administrative cost. Stock dividends simply are much more costly to administer than are cash dividends, and this out-of-pocket expense works to their disadvantage.

More-Popular Trading Range A stock split and, to a lesser extent, a stock dividend are used to place the stock in a lower, more-popular trading range. By so doing, more buyers may be attracted, increasing the number of individual holders.

Whether this wider ownership is a thing of value is another matter.

Chapter I1 Dividend Policy: Theory and Practice 327 Since 1982, the United States has had a huge run-up in its overall stock market.

Yet few companies have share prices in excess of $80. The reason is simply that stock splits and, to a lesser extent, stock dividends are used to keep share price at what many regard as an appropriate trading range. (The notable exception is Berkshire Hathaway, which under Warren Buffet has never split its stock and has reached a high of $81,000 per share!) Finally, trading volume tends to increase after a stock split or dividend, giving the stock more liquidity. For these reasons, the

"more-popular trading range" motivation for stock splits and dividends is widely supported.

Informational or Signaling EfSect The declaration of a stock dividend or a stock split may convey information about hture earnings to investors. As taken up earlier in this chapter and in the previous chapter, there may be asymmetric information between management and investors.

As with capital-structure and cash dividend changes, a stock dividend or split may connote more convincingly management's belief about the favorable prospects of the company. In this sense, the stock dividend or split is an attention-getting device.

Whether these signals are more convincing is an empirical question. Here there have been a number of event type of studies.lBA s we know, such studies attempt to isolate the abnormal return associated with a particular event-in this case, a stock dividend or split. The abnormal return is simply the residual after risk-adjusted market movements (beta), and perhaps other factors, have been taken into account. If stock dividends and splits have a positive signaling effect, a plot of the cumulative residuals might look like that shown in Fig. 11-1. In the sev-

I8A classic carlicr study is by Eugene F Fama, Lawrence Fisher, Michael Jensen, and Richard Ron, "The Adjustment of Stock Prices to New Information," Inlernatinnal Econmnic Review, 10 (February 1969), 1-21. Subsequent studies include Mark S. Grmblatt, Ronald W. Masulis, and Sheridan Titman, "The Valuation Effects of Stock Splits and Stock Dividends," Journnl of Finirncial Economics, 13 (Deccmbcr 1984), 461-90; Christopher G. Lamoreux and Percy Poon,

"The Market Reaction to Stock Splits," Journal of Finance, 42 (December 1987), 1347-70; Michael J. Brenmn and Thomas E. Cooeland. "Stock S~litsS. tock Prices and Transaction Costs." lournal of Financial Economics. 22 (October F I G U R E 11-1 5 Cumulative daily 2 abnormal returns 2 around stock dividend or stock split 2 announcement 2 9 +-

2 3 m E 40 2

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