ON THE MOTIVATION FOR PAYING SCRIP DIVIDENDS

Why do companies in the United Kingdom pay scrip (i.e., in stock) divi dends? Are tax savings the sole motive for this option? If so, are all tax-loss companies offering this option? Or is this option driven by other motives, such as cash savings, signaling, and agency conflicts? In this study, I provide some insights into the motivation for scrip-d ividend payment by comparing the operational performance and other cha racteristics of all companies that distributed scrip dividends with th ose of a control group of non-scrip-paying, but otherwise similar, fir ms. Scrip dividends are offered by an increasing number of companies i n the United Kingdom as an option whereby shareholders are able to cho ose between receiving dividends in cash or the equivalent in the form of shares (scrip). Companies stress tax savings when they offer this o ption because, unlike cash dividends, the scrip option is not subject to a payment of the advanced corporation tax (ACT). I find that there are no significant differences in the scrip and non-scrip-paying firms ' tax exposures. Compared to the control sample, firms that issue scri p dividends do not report a higher proportion of irrecoverable ACT in their accounts, nor do they generate a high proportion of their earnin gs overseas, earnings on which the ACT cannot be claimed. My results a lso show that this option is not driven by cash shortages, nor is it a substitute for external finance and/or a cut in cash dividends. Howev er, I find that firms that pay scrip dividends are, on average, large, and have high dividend yield, suggesting that the cash saved is subst antial. However, these firms already have high cash-flow balances and low growth opportunities. The overall results suggest that firms in th e UK do not appear to be making the optimal financial choice for their dividend policies. Like stock dividends and dividend reinvestment pla ns in the US. scrip dividends provide both firm and shareholders with many benefits. Companies are able to retain cash without altering thei r payout policies or raising new funds in the capital markets; thus, c ompanies that use this option can save on borrowing costs, underwritin g fees, other issue costs, and avoid negative signals of new equity. A t the same time, they provide their shareholders with the opportunity to increase their holdings without incurring any transaction costs. In addition, the UK institutional setting and relevant tax code provisio ns allow companies to derive tax benefits from this option. Unlike cas h dividends, this option is not subject to ACT. This tax is first paid when a company declares cash dividends and is deducted from its corpo ration-tax liability nine months after the accounting year-end if divi dends are paid from domestic earnings and if taxable profit is higher than gross cash dividends. If these two conditions are not met, surplu s ACT is carried in the accounts and set off against preceding or imme diately following periods. For companies with no previous or foreseeab le future taxable profit, ACT is written off as a loss against reserve s. Thus, companies with prospective ACT loss are more likely to pay sc rip, rather than cash, dividends. However, scrip dividends are not cos tless. Firms incur administrative costs in Petting up and running the scheme, such as the costs of advertising the option, preparing and mai ling the scrip-dividend prospectus, and printing and allocating the ne w shares. Moreover, scrip dividends impose costs on the firm's shareho lders. This option is not offered to foreign investors. For some domes tic investors, it is taxed differently from cash dividends. While the tax credit associated with cash dividends can be claimed by all invest ors, the tax credit on scrip dividends can only be claimed by tax-payi ng individual investors. Individuals who have reliefs and allowances i n excess of their income, as well as corporate investors, forgo the ta x credit when they opt for scrip dividends. Thus, corporate and nontax able individual investors are likely to prefer cash dividends; individ ual shareholders taxed at a higher rate of income tax may opt for scri p dividends for which the firm issues additional shares. However, such additional shares could result in a dilution of control for sharehold ers who opt for cash dividends, and a loss in future dividend increase s if scrip dividends limit the scope for such increases. Why, then, do companies issue scrip dividends? One possibility is that individual t ax-paying investors request this option from their companies, which su ggests that companies are subject to monitoring by atomistic sharehold ers while large shareholders, such as corporate investors, are passive owners. I suggest a number of areas for further research that will as sess the extent to which the granting of this option is driven by nonf inancial considerations.