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Dr. A. Roxendall
CITI Institute

Practically every investor is, at some time or another, concerned with the matter of dividends received on his shareholdings. Ordinarily, the mere declaration of a dividend on stock involves little or no problem, but certain circumstances surrounding dividend payments nevertheless need clarification to prevent misunderstandings.

These matters relate to such questions as the nature of dividends, the various types of dividends, how dividends affect the value of a stock after payment, and who is entitled to receive the dividend when stock changes hands around the time of payment. It is also necessary to clarify such technicalities as "holders of record" and "ex-dividend" dates.

Finally, there is the problem of "rights" on stock, which sooner or later arises for most investors owning a fairly extensive portfolio of stocks in different companies.

Nature of Dividends

The common stockholder is a part owner of his corporation and of all its surplus wealth or equity, after allowing for the current and fixed liabilities (including bonds and preferred stocks which have prior claim on his company's resources). After such claims are satisfied, the residual wealth and assets of the corporation belong to the common stockholder in direct proportion to the percentage of total outstanding common stock which he holds. It is clear, therefore, that any profits which the company makes will go to increase this equity in the common stock, just as any losses or payments which the company makes will go to reduce this equity.

Thus, if the corporation makes profits on its common stock and does not pay them out in cash dividends, such profits remain to increase the balance or equity behind the common stock, and so increase the basic value of the stock. On the other hand, if the company pays out all of such profits accruing to the common stock in dividends, it is equally plain that the company no longer has those profits, and the equity, of theoretical value of the common no longer has those profits, and the equity, or theoretical value of the common stock, is reduced by just the amount which the company pays on the common stock in the form of cash dividends.

So, every time a corporation makes a profit, the worth of its common stock is raised to the owners of that stock. And every time the corporation pays out a portion of that profit on its common stock, the worth of the stock is decreased to its owners by just the amount of that dividend.

A specific Example

Let us suppose that Mr. Brown bought one share of American Consolidated Cotton (a mythical concern) in January at $100, which we shall consider the theoretical, as well as the actual, value of the stock at that time. Now, let us suppose that his company completes a profitable deal in which the total profit divided by the number of common stock shares outstanding-amounts to $10 on each of those shares. The theoretical value of Mr. Brown's stock has been increased by just the amount of that profit, or $10 per share. (It is another question whether the actual market price of American Consolidated Cotton will immediately advance the amount of that increased value for the stock and sell $10 in the open market. That depends upon ?market conditions, ? and we are now speaking only of the theoretical side of the question.)

Theoretically, in any case, Mr. Brown has already benefited from this $10 profit on his share of stock, since the value of his stock has been increased by that amount, whether he sells it for that increased price or not.

Now, let us suppose that the directors of American Consolidated Cotton decide to pass on this profit-or increased equity-to the owners of the business, the common stockholders. They declare a dividend of $10 per share on the common stock of the corporation. When that dividend is paid. Mr. Brown will receive $10 in cash. He will also still have his original stock. He may, therefore, feel that he has just realized a "profit" of $10 on his share of stock. But when that dividend is paid, the value of his stock must theoretically drop the amount of the dividend and will go back from $10 to only $100. So that instead of having a $100 share of stock and $10 in cash.

Of course, Mr. Brown's stock after the dividend payment is worth just as much as when he bought it at $100. But the point is that the true increase in his wealth came with the increase in profits of his corporation and the consequent increase in value of his stock, not with the actual payment of such profits to him in the form of a dividend.

"Stockholders of Record"

The value of a stock drops by the amount of the dividend which is paid upon it. It is also clear that the value should theoretically drop at the exact moment when the corporation pays out such dividend to the owner of its stock.

But, in practice, this is not the case since corporation must have time to make out its dividend checks, address, them, mail them, and tend to other details. The corporation's stock may be constantly changing owners, and it takes some time to make such changes of name, address, etc., on the corporation's records. The corporation must, therefore, set a final date after which the change of its stockholders? records of ownership will have nothing to do with the individuals who are to receive any particular dividend. When a corporation declares a dividend, therefore, it declares such payment to "stockholders of record" on a certain date, usually about a week or two before the date on which the dividend is payable.

This means that when checks for the dividend are mailed on the date on which the dividend is payable, they will be mailed only to those individuals who were shown to be owners of the company's stock on the official date when the company's stock transfer books were closed for payment of that dividend. The company, therefore, has plenty of time to issue new stock to the new owners which were reported to the company before the "record date" for payment of the dividend. Any changes in ownership of stock made after that date of record will not be recognized by the corporation with respect to that particular dividend, and the payment of such dividend will go to the individual in whose name the stock was issued on the date of record.

"Ex-Dividend" Date

But there is one more pint to clarify on this matter of dividend payment, and that is the "ex-dividend" date.

Since we have seen that the price of a stock usually drops the amount of dividend paid on it, the New York Stock Exchange and other major exchanges fix a specific date on which this price change should become effective on the particular exchange in question.

This date is called the "ex-dividend" date and usually occurs (by stock exchange ruling) five full business days prior to the "stockholder of record" date fixed by the corporation. Whereas the purpose of the "stockholder of record" date is to determine to whom the corporation will pay the dividend, the purpose of the ex-dividend date is to fix the time when the price of the stock is to change. It precedes the record date sufficiently enough to allow those investors who purchase up to the ex-dividend date to have their names properly recorded on the books of the company as recipients of the dividend here under consideration.

Thus, a corporation on June 10 declares a $2 dividend on this stock payable on July 1 to holders of record as of June 25. Assume that the Stock Exchange fixes the ex-dividend date as of June 18.

On June 18, the stock goes ex-dividend and usually will drop by the amount of the dividend (unless the market is rising sharply, or unless the particular stock is extraordinarily strong at the time). In this case, if the stock was selling for $50 on June 17, it probably will drop to $48 on June 18, the $2 difference being the amount of the dividend.

Now, the important point is that if you buy the stock on the ex-dividend date, you don't receive the dividend, regardless of what the record date is! This is because the stock has already dropped (usually) by the amount of the dividend. In other words, the drop in price offsets the dividend, and vice-versa.
Now, if a stock is traded between the ex-dividend and record date, there may have to be some adjustment between buyer and seller, depending on the particular situation.

For example: If a holds the above stock until June 18 (the ex-dividend date but before the record date), his name will be forwarded to the corporation to become a holder of record. But if he sells the stock on June 24 to B, and B holds is until June 25 (the "record" date), a may be liable to B for the dividend. Actually, a matter like this is handled by one?s broker. "Due bills" are used to indicate such liability.

Situations like this are comparatively rare, but this illustration is presented to clarify the relationships and obligations which exist in such cases.

Market Price Drops on Ex-Dividend Date

As previously stated, on the ex-dividend date for any stock, the market price of that issue theoretically drops the amount of its dividend. If the stock closed at $110 the day before it goes ex-dividend (and the amount of the dividend to be paid is $10), then theoretically the opening price the next morning, on the ex-dividend date, would be only $100.

This is equitable because the individual who owned the stock the evening before would be entitled to receive the $10 dividend while the individual who bought it the next morning would not be entitled to receive such payment. In practice, of course, the decline is not always exactly the amount of the dividend, depending upon the ordinary action of supply and demand for the stock in question. But such stock would almost certainly drop approximately the amount of the dividend for which it went "ex."

The True Significance of Ex-Dividend

The justice of the ex-dividend date and its accompanying adjustments is therefore clear; likewise the fact that from a theoretical standpoint it makes absolutely no difference whether the owner of a stock receives a dividend on his holding or not. If he does not receive such dividends, the equity of his stock is not affected. And if he does receive such dividends, the value of his stock, theoretically, drops automatically by the amount of the dividend which he receives.

All that we have said with reference to the cash dividend applies equally to both common and preferred stocks or to any stock on which dividends are paid, including stock, property and scrip dividends, and the granting of rights.

Types of Dividend

In lieu of a cash dividend, a corporation may elect to pay a stock dividend. Some companies pay stock dividends on a regular basis, while others disburse them only as an extra form of compensation. Any stock dividend is payment by the issuing corporation of additional stock on the already held by the corporation?s stockholders.

Payment of such a stock dividend automatically reduces the market price of the stock by the of the dividend, just as in the case of a cash dividend. The reason why the price of a stock drops in case of a stock dividend is just as plain as in the case of a cash dividend. In the latter case, the company reduces its actual cash resources by the amount of the dividend. The number of shares of common stock (or part ownerships) remains the same, but the assets applicable to them are reduced. In the case of a stock dividend, the company pays out no cash and its cash assets therefore remain the same as before. But it increases the number of shares of common stock, or part ownerships, so that the assets must be divided by a larger number of common stock shares (or claims of ownerships), and the equity behind each share is thus reduced.

Other, less commonly used types of dividends are property and scrip payments.

Property dividends are simply dividend payments in assets other than cash, with the most usual form being securities of other companies. Governmental divestiture rulings have been largely responsible for this type of payment. A major example is the E.I. Du Pont case whereby Du Pont distributed to its shareholders shares of General Motors stock it owned. (A distiller once even made a dividend distribution of cases of liquor.)

A scrip dividend is a promise by the corporation to pay a cash dividend sometime in the near future. This form of dividend is used when current cash reserves do not allow a payment but expectations are that cash for this purpose will be available in the near future.

Granting of "Rights"

Another method of paying stockholders is that of offering rights to subscribe to additional stock, either of the same issue or some other, at prices below the actual market price for such stock. If a corporation?s stock is selling in the open market at $100, and the corporation offers its holders the right to buy additional stock at $80, then it is apparent that the holder can buy the new stock at $80 and sell it in the open market at not far from $100, thus realizing a profit of nearly $20 per share on each share thus acquired.

Calculating the Value of "Rights"

Calculating the value of rights is generally considered an arduous task or even a mysterious ritual, known only to the "experts." In practice, there is nothing difficult or intricate about it, once the principle involves is understood.

For example: In June 1929, the United State Steel Corporation decided to raise additional funds (for the purpose of retiring bonds and other corporate purposes) by offering additional stock, at advantageous prices below the actual market price, to individuals who already held shares of that common stock. United State Steel common stock was selling at about $190 in the open market, and - in order to understand the theoretical compilation of values for dividend rights - we must assume that the actual market price of the stock is also its true asset (or equity) value.

The Approximate Method of Calculating "Rights"

With U.S. Steel selling at $190 in the open market, holders were offered the right to buy one additional share of common at $140 for every seven shares which they currently owned. It is evident that the holder of U.S. Steel commons was getting a right to cash value, since he had to pay only $140 for something whose prevailing market value was around $190, profiting to the extent of about $50 for every share which he could buy at the lower, or "bargain," price.

Specifically, if the holder could buy one new share at $140 and sell it again at $190, for every share held, the worth of his "privilege to subscribe" would be $50. Since he can buy only one new share, and make this $50 profit on it, for every seven shares held, the worth of a right on one old share will be one-seventh of $50, or about $7 as stated above. This is the simplest and easiest method of calculating the approximate value of rights.

The above simple method gives only approximate results however - results somewhat higher than the actual and more technical methods of figuring the exact value of such right. Assuming that the true value of the old common stock of United States Steel Corporation was its market price of $190, the shares after the new additional stock is issued will not be worth that figure, because the total number of shares will have been increased by one-seventh again as many as before the issuance of the new stock. Now, if the company sold this new stock for the theoretical asset value and the actual market price of $190, then the total amount of new stock, after the additional issue, would still be worth $190 per share.

But the company does not get "full value" for the additional stock it sells. It gets only $140 per share instead of $190. On the additional stock issued, therefore, there will be a decline of $50 per share in value from the true value. The amount of this new stock issued is equal to one-seventh of the stock already outstanding which is worth $190 a share. When the new stock is issued, therefore, there will be seven-eights of the new total with a value of $190 per share and one-eight of the new additional total of stock with a value of only $140, or $50 less. This reduced value of the one-eight of the total is spread out over the entire eight-eighths, however , since every new share must have the same value. The actual value of the new shares, therefore, will be reduce by one-eight of that $50-per-share decline in the new stock offered, or a decline in the average stock of $6,25. This is the true value of one right, therefore, but, to reach the figure logically we must go on with our computations.

A Formula for Calculating "Rights"

After the new stock is issued, it is seen that each share of the new stock will have an actual value, not of the previous $190 per share, but $6,25 less than that or a new value of only $183.75. Now the holder of an old share who can buy a new one for $140 does not receive quite so much value as if the new stock were going to be worth $190 instead of only $183.75. The actual value for every share of the new stock he can buy at $140 and sell at $183.75 is, of course, the difference between subscription price and selling price, or $43.75. But for each share of stock now held he can buy only one-seventh of a new share at the reduced price, so the true value of his right per old share is one-seventh of $43.75, or $6.25. This is the true and actual value of his right to buy the new stock, and it will be noticed that this true value - arrived at by rather devious theoretical calculation - is somewhat less than the approximate value (about $7.00) we arrived at through the easier and simpler method before described.

We have gone into somewhat intricate details in explaining the true method of figuring actual rights on fundamental grounds. Once the principle involved is understood, the mathematical procedure may be summed up in the following formula:

Let "X" equal the number of shares of old stock necessary to buy one new share.
Let "Y" equal the market price of the old stock.
Let "Z" equal the purchase price of the new stock.

The formula is then as follows:

(Y - (Y-Z/X+1)-Z) ÷ X = value of one right.

Working this original formula down by algebraic reduction, we get the final simple formula:

(Y - Z)/(X+1) = value of one right

Taking the previous example of "Steel," we have Y (190) minus Z (140), or 50, divided by X (7) plus 1, or 8 giving $6.25, or the value of one right.

This formula seems the simplest one of all the various forms used for computing such values of stock rights.


The market price of a stock on which rights to subscribe have been declared drops theoretically, and usually in a practical manner, just the value of the right declared, on the date when the stock goes "ex-right," just as we have seen that a stock drops the value of its cash dividend, or its stock dividend, on the day when the stock goes ex-dividend.

We have seen that the holder of one old share of United States received a right worth $6.25 to him if he cared to exercise it, or take advantage of the right to buy additional stock at the named price below the actual market. Such right are transferable and negotiable. Therefore, if the holder did not care to take on any more "Steel" common, he might have sold his rights to someone else. When right are valuable, there is usually an active market for trading in such rights, and most organized stock exchange have facilities for listing and trading in them.

If the holder of "Steel" has decided to sell his rights in the open market, therefore, he could have done so, theoretically - and practically, too - at a price of $6.25, or 6¼, on the New York Stock Steel would drop the day it went "ex-rights," theoretically, so that in point of practice it makes very little difference whether the holder of a right to subscribe actually exercise the right himself or sells it to another in the open market.

Sell or Exercise All "Rights"

The important thing, however, is that he do one thing or the other with his right before they expire. Subscription rights are usually issued with a definite expiration date, after which the offer to subscribe to additional stock closes. The rights thereafter have no value whatever, so the importance of exercising or selling one's rights before the date of their expiration is readily apparent. Between the time of offering the rights and their expiration date (generally about a month or less), the price at which such right are traded fluctuates with the varying market prices for the stock to which the right to subscribe apply. Following the drastic declines late in 1929, rare and interesting situations developed wherein the market value of some stocks dropped below prices at which rights were offered to additional stock. The rights thus lost their own value and in some cases were cancelled.

No general rule, naturally, can be laid down for the time to sell one's rights, if that is the course decided upon, any more than any general rule can be laid down as to just when the highest price for any stock will be reached. The price of rights (as well as the price of the stock itself, of course) more often declines than advances as the time expiration of the rights approaches. In theory, this is borne out logically by the delay which most holders of right practice in deciding whether they will exercise them or sell them. The percentage who finally decide to sell their rights instead of exercising them generally make the decision not so very far from the expiration date, and the pressure of this volume of rights on the market for sale is likely to exercise a depressing effect upon the market value for the "rights," as well as for the stock it self. Usually, however, the market for the stock will affect the price for the rights rather than vice-versa.

Logical Time to Sell "Rights"

Therefore, if the holder of right to subscribe decides to sell decides to sell his rights instead of exercising them, he will more often than not realize a better price for his rights if the sells early in the period of their life and active trading, rather than wait until close to the expiration date.

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