Why Do Companies Pay Stock Dividends? The Case of Bonus Distributions in an Inflationary Environment

Abstract

We assess the market valuation of an unusual form of stock dividends, referred to as bonus distributions, which are carried out by transferring the accumulated equity reserves, mainly the inflation revaluation equity reserves, to paid-in capital leaving the total equity unchanged. In the absence of cash substitution and transaction cost effects, we find positive excess returns on the announcement dates, particularly for the financially weak firms, such as the non-cash-dividend-paying firms. We relate our results to the 'paid-in capital hypothesis' under which firms opt for bonus distributions to mitigate the impact of inflation on their eroding paid-in capital, to reduce their leverage defined as debt-to-paid-in-capital ratio, and to increase their credibility and borrowing capacity in a market of limited access to external equity financing. Although our results are also consistent with the retained earnings and signaling hypotheses, we find no support for the attention-getting, and a weak support for the liquidity enhancement hypotheses observed in other markets.