Chapter 14 Distributions to Shareholders: Dividends and Share Repurchases 455the money that stockholders who elect to use the DRIP would have received to a
bank, which acts as a trustee. The bank then uses the money to purchase the cor-
poration’s stock on the open market and allocates the shares purchased to the par-
ticipating stockholders’ accounts on a pro rata basis. The transactions costs of buy-
ing shares (brokerage costs) are low because of volume purchases, so these plans
bene! t small stockholders who do not need current cash dividends.
A “new stock” DRIP invests the dividends in newly issued stock; hence, these
plans raise new capital for the! rm. AT&T, Xerox, and many other companies have
used new stock plans to raise substantial amounts of equity. No fees are charged to
stockholders, and some companies have offered stock at discounts of 2% to 5%
below the actual market price. The companies offer discounts because they would
have incurred " otation costs if the new stock had been raised through investment
bankers.
One interesting aspect of DRIPs is that they are forcing corporations to reexam-
ine their basic dividend policies. A high participation rate in a DRIP suggests that
stockholders might be better served if the! rm simply reduced cash dividends,
which would save stockholders some personal income taxes. Quite a few! rms have
surveyed their stockholders to learn more about their preferences and to! nd out
how they would react to a change in dividend policy. A more rational approach to
basic dividend policy decisions may emerge from this research. Companies switch
from old stock to new stock DRIPs depending on their need for equity capital.
Many companies offering DRIPs have expanded their programs by moving to
“open enrollment,” whereby anyone can purchase the! rm’s stock directly and
thus bypass brokers’ commissions. ExxonMobil not only allows investors to buy
their initial shares at no fee but also lets them pick up additional shares through
automatic bank account withdrawals. Several plans, including ExxonMobil’s, offer
dividend reinvestment for individual retirement accounts; and some allow partici-
pants to invest weekly or monthly rather than on the quarterly dividend schedule.
With all of these plans (and many others), stockholders can invest more than the
dividends they are forgoing—they simply send a check to the company and buy
shares without a brokerage commission.
SEL
F^ TEST What are dividend reinvestment plans?
What are their advantages and disadvantages from both stockholders’ and
" rms’ perspectives?14-5 SUMMARY OF FACTORS INFLUENCING
DIVIDEND POLIC Y
In earlier sections, we described the theories of investor preference for dividends
and the potential effects of dividend policy on the value of a! rm. We also dis-
cussed the residual dividend model for setting a! rm’s long-run target payout
ratio. In this section, we discuss several other factors that affect the dividend deci-
sion. These factors may be grouped into four broad categories: (1) constraints on
dividend payments, (2) investment opportunities, (3) availability and cost of alter-
native sources of capital, and (4) effects of dividend policy on rs. We discuss these
factors next.