When a corporation makes profits, the payments made to the shareholders are referred to as “dividends”, and the payouts are made as a distribution of the profits. The payments made are a small proportion of the total profit made since the rest is reinvested in the company. The dividends are for the company shares outstanding, which is the company’s outstanding equity. In some cases, the company may reacquire the shares through a process called “Cash Repurchases” and involves the distribution of cash to the shareholders with the purpose of reducing the outstanding equity. The share repurchases and dividends payment are related such that, the repurchases to the stocks reduces the number of dividends payable to the shareholders. However, a company may choose to re-acquire its shares when there is the need to reduce the stock outstanding.
Notably, the share repurchasing can be used as a substitute for dividends paid to the shareholders. For instance, the recent changes in the features of public firms have resulted in the reduction in cash dividends made by companies. In the regard, the payment of dividends to stakeholders can be attributed to the emergence of share reacquisitions as a means of allocating cash to shareholders. The shifts in the preferred company payoutshave been witnessed in corporations, a trend which can be attributed to the companies’ preferences to reacquire a certain number of shares from the shareholders in exchange for money. The trend poses a challenge to the continued use of dividends in distributing profits among shareholders.
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In certain companies, the payments and cash repurchases are incorporated when the policies require the company to make payment for shares through dividends. The increase in share repurchases since the 1980s has brought tremendous changes to company policies, with the payment of dividends being incorporated with the repurchasing method in certain companies’. In the companies’ that incorporates the two methods, the payment of dividends is considered a traditional method of distributing income and therefore not easily eliminated. In that case, the changes in the payment methods require integration rather than a replacement to avoid cases of failure. Despite the incorporation, the dividends method may become outdated with time, or sometimes may be transformed to meet the needs of the shareholders.
Furthermore, a company may reacquire the shares outstanding with the purpose of reducing publicly traded shares. When the company share price reduces, repurchasing the stock is beneficial to the non-sellers while extracting value from sellers. The company can make profitable repurchase when a large percentage of the shareholders are retail investors, who are willing to sell their shares when the share price reduces. Besides, a company that makes repurchases has some larger reserved earnings as compared to a corporation that uses dividends to distribute the profits. A company that wants to retain more of its earnings will prefer to use share repurchases to using dividends. The company’s preference explains the reduction in the usage of dividends to distribute profits among the shareholders.
The emergence of the share repurchases in the corporate sector has resulted in the diminishing use of dividends as a profit distributive mechanism. In this case, the share reacquisition method can be used as an alternative to the dividends strategy, and in most cases, the two methods are incorporated in companies’ that used the payments as a traditional method of distributing income. The companies that incorporate the two approaches of sharing profit find it challenging to replace the dividends. However, the share repurchase method is essential in retaining a greater percentage of the company income and therefore preferred to the dividends method by companies.
References
Floyd, E., Li, N., & Skinner, D. J. (2015). Payout policy through the financial crisis: The growth of repurchases and the resilience of dividends. Journal of Financial Economics , 118 (2), 299-316.
