Chapter 11 – Corporate Dividends

Corporate Dividends

• Distribution:  Strictly, refers to payments to shareholders that are not a sharing of profits; loosely, refers to any type of payment to shareholders
• Dividend:  Strictly, refers to a distribution of a corporation’s profits to its shareholders; loosely, refers to any kind of payment made to shareholders

Types of Dividends

• Cash dividend: cash distribution made by corporation
  • Dividend reinvestment plan: plan allowing shareholders to immediately use cash dividends to purchase more stock; usually called DRIPs
• Property dividend:  distribution of some form of property by a corporation
• Share dividend: distribution by a corporation of its own shares

Restrictions Relating to Dividends

• Solvency and excess tests
• Legally available funds
• Tests for distribution
  • Balance sheet test
  • Equity insolvency test
  • Modern test
• Contractual limitations
• Preferences
• Classes of shares

Tests for Distribution

• Balance sheet test:  test to determine if dividends can be paid in which equity exceeds liabilities (also called excess assets test)
• Equity insolvency test:  test to determine if dividends can be paid in which corporation must be able to pay debts as they become due
• Nimble dividends test:  test to determine if dividends can be paid in which corporation must have current profits

Tests for Dividends

• Some jurisdictions use earnings tests and may even combine two or three tests for the payment of dividends.
• These state statutes may mandate that dividends may be paid only from certain corporate accounts.
• Generally, these statutes provide that dividends may be paid only from the retained earnings account (the net profits accumulated by the corporation) or its surplus account (the value of the corporation’s net assets that is greater than its stated capital).

Illegal Dividends

• Distributions paid when corporation is insolvent or from unauthorized accounts

Procedure for Declaring and Paying Dividends

• The decision to declare a dividend is made by the board of directors, either by majority vote at a meeting or by unanimous written consent action taken without a meeting.
• The decision is recorded in the minutes or the written consent as a resolution.

Stock Split

• A stock split is a division of outstanding shares (also called a share split).

Purchase by a Corporation of Its Own Shares

• A corporation may acquire all or some of its own outstanding shares from shareholders if state corporations statutes and the articles of incorporation so permit and if the corporation is solvent or would not be rendered insolvent by the transaction.

Purchase by a Corporation of Its Own Shares

• The corporation may wish to redeem or reacquire its shares for a variety of reasons, including
  • a desire to decrease supply of the stock and thereby increase price
  • a desire to thwart shareholders from selling the shares to outside parties
  • a desire to improve its equity-debt ratio
  • a desire to increase earnings per share by reducing the total number of outstanding shares

Key Features of Corporate Dividends

• A dividend is a distribution of a corporation’s profits to its shareholders.
• Dividends may be in the form of cash, property, or shares of the corporation. 
• Generally, to distribute a dividend, a corporation must be solvent, meaning that it is able to pay its debts as they come due or its assets must equal or exceed its liabilities.
• Many state statutes regulate the funds from which dividends may be paid.
• Dividends must be uniform within a class but can vary from class to class.
• The decision to declare a dividend is made by the board of directors, who will set a record date for determining the shareholders entitled to a dividend.
• Shareholders who receive cash must pay taxes on the amount received, shareholders who receive property dividends must pay taxes on the fair market value of the property received, and shareholders who receive share dividends pay taxes at the time the share is eventually sold.