Dividend reinvestment plans (DRIPs) allow shareholders to reinvest their dividends in the company itself by purchasing additional shares rather than being paid out in cash.

Understanding how dividend reinvestment plans work

Under dividend reinvestment plan, the company gives any cash dividends that investors would have received in a bank, which acts as a trustee. The bank then uses the money to repurchase the companys existing stock in the stock market. The bank then allocates the shares purchased to the participating stockholders accounts on a pro rata basis.

Some firms that use dividend reinvestment plan will allow stockholders to purchase stock at a price slightly below the market price.

Why do firms use dividend reinvestment plans?

Companies decide to start, continue, or terminate their dividend reinvestment plans for their stockholders based on the firms need for equity capital. A firm is likely to start using new stock DRIPs if it additional equity capital.