Shareholder's Wealth

Stock Dividends

A Strategy for Increasing Corporate & Shareholder Wealth

By Thomas E. Nugent

Overview

The primary goal of corporate management is to increase shareholder wealth. Historically this strategy has been achieved through the implementation of a plan to grow company sales followed by profitability and the initiation and subsequent increase in cash dividends as a reward for investors. Corporate managements have been proud to announce dividend increases to shareholders because it is a sign of a corporate success and prosperity. The common stock of companies that have paid cash dividends for many years receive market recognition by being known as blue chip stocks. Traditional models designed to value equities place critical importance on cash dividends. In these models, the valuation of a common stock is predicated upon the discounted value of anticipated dividend streams1. Academic studies have demonstrated that above average total returns can be achieved by investing in the Dow Jones Industrial stocks with the highest cash dividends2. Institutional investors have created mutual funds emphasizing payment of cash dividends by focusing on the income component of equities as a primary investment goal. Investor endorsements of cash dividend strategies have provided encouragement to corporate management to pay cash dividends as the distribution medium of corporate wealth.

One Problem with Cash Dividends

The strategy of distributing corporate wealth through cash dividends is compatible with the investment objectives of tax-exempt equity investors. The tax exempt or tax-deferred investor selects securities without regard to the tax consequences of profit distribution because there are no taxes payable. Examples are participants in retirement plans or charitable entities where there is virtually no need to distinguish between increases in value brought about by capital appreciation or dividend income. On the other hand, there are many investors who are subject to both ordinary income taxes and capital gains taxes. These investors bear the brunt of tax laws that impose ordinary income taxation on dividend income. Given these two investor classes, corporate management