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The dividend reinvestment plan puzzle

  • Harold Bierman
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    It is a rare Fortune 500 firm that does not offer its shareholders the opportunity to participate in a dividend reinvestment plan (a DRIP). There are a wide variety of plans but the typical plan has zero transaction cost for the investors. Some plans offer a price discount from the market price. The puzzle is, 'Why do dividend reinvestment plans exist?' If tax effects are ignored, the dividend policy of a firm does not matter. If taxes are considered and there are significant taxes, both retention and share repurchase are more desirable than the payment of dividends. Arguments are offered that dividends reduce risk, act as discipline on management, and supply information to the market. But all three of those objectives can be obtained in alternative ways. In some situations a dividend payment might reduce the transaction costs incurred by investors who want cash flow from the firm, but normally the saving in transaction costs is not significant. Thus most academics interested in finance argue in favour of either constant dividends or reducing them to zero. Most corporations that can afford to pay dividends, pay them. It is conventional corporate finance policy to increase dividends systematically. On top of this dividend policy puzzle we now have the dividend reinvestment plan puzzle. If investors want to reinvest in a firm, why does the firm not retain earnings?

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    Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

    Volume (Year): 7 (1997)
    Issue (Month): 3 ()
    Pages: 267-271

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    Handle: RePEc:taf:apfiec:v:7:y:1997:i:3:p:267-271
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