When a corporation makes a profit, there are a couple of potential outcomes for that profit. One, the corporation can choose to reinvest that profit in its operations, thus turning it into retained earnings. Two, the corporation can choose to hand it as well as retained earnings from earlier periods out to the corporation’s shareholders, thus turning it into dividends. However, it is important to note that dividends can be divided into normal dividends and special dividends, which is based on whether the dividends are handed out on a regular basis or not. Dividends that are handed out on a regular basis are called normal dividends. In contrast, dividends that are not handed out on a regular basis are called special dividends, thus explaining their name. Corporations are very careful to separate one from the other because of the potential impact on their operations. There are a number of potential explanations for why a corporation is issuing a special dividend, each of which comes with its own potential consequences:
The reason for a special dividend can be as simple as the corporation having some extra cash on hand. This can happen for a very wide range of reasons. Sometimes, there was some kind of event that isn’t expected to repeat in future periods, with an excellent example being the sale of a business unit. Other times, the extra cash came from the gradual accumulation of retained earnings in period after period. Whatever the case, a corporation can choose to hand out the extra cash that it has on hand because it has no better purpose in mind for it. Having said that, it is important to mention that this is something that can backfire on corporations. For instance, there are some shareholders that can interpret such special dividends to mean that a corporation has run out of potential for growth because it is choosing to hand out its extra cash rather than invest it in something more productive. This is not guaranteed to be the case, but this is something that can come to be believed by the shareholders, thus increasing the chances of them making choices that the corporation’s executives might not like.
Corporations have been known to use special dividends as a way to build loyalty in their shareholders. Something that can enable them to pursue more productive courses of action while minimizing potential interference. In short, a lot of shareholders have a very short-term perspective when it comes to their investments, with the result that they want corporate leadership to make choices that will maximize their profits in the short run. The problem is that such policies are by no means guaranteed to be the best decisions for the corporations in the long run. For example, this kind of thinking makes it quite difficult for corporations to make investments that won’t pay off until a long time in the future, thus closing off entire swathes of opportunities to them. Likewise, chances are good that interested individuals have heard plenty of horror stories about corporations sacrificing their long-term prospects for the sake of their short-term profits, with an excellent example being environmental disasters caused by excessive cost-cutting when it came to inspection and maintenance.
Of course, corporate leadership isn’t helpless when it comes to such issues. As such, they can take various steps to boost shareholder loyalty in an effort to convince them to stick around for the long run, thus encouraging them to take a more long-term perspective as well. One excellent example would be regular engagement, which can get shareholders involved with the relevant corporation in more than just a purely financial sense. Another excellent example would be special dividends, which are about as simple and straightforward as a shareholder loyalty-building method can get. In any case, shareholders that feel a greater sense of loyalty to the corporations that they have invested in are very useful for those corporations, not least because that opens up a whole new world of options for corporate leadership.
For those who are unfamiliar, a corporation’s capital structure is its particular mix of debt and equity. When a corporation changes its capital structure, that is called a capitalization change. Sometimes, it can be beneficial for corporations to change their capital structure so that there is a bigger proportion of equity to debt, with a special dividend being one way for them to achieve this. After all, dividends are accounted for using retained earnings, which fall on the equity side of the balance sheet. As for why a corporation would want to be funded using a higher ratio of debt to equity, the answer is that it is a matter of efficiency. Basically, equity is expensive in its own way, meaning that a corporation that is over-reliant on equity is inefficient because it is passing up on debt-based options to fund its operations that might be cheaper. By correcting this issue, corporations can even make themselves look more attractive on their financial statements, which can be very useful for convincing a wide range of stakeholders and potential stakeholders to do what they want.
What Do Special Dividends Mean for Shareholders?
People who are interested in stocks that are offering a special dividend should monitor the situation with care and consideration. This is because shareholders can react in a very wide range of ways to such occurrences, not least because they can happen for such a wide range of reasons. For example, some shareholders might choose to sell their shares upon receiving the special dividend, though this can backfire on them because such occurrences tend to reduce the share price. Something that is particularly true when a lot of other shareholders choose to sell as well. Likewise, other shareholders might choose to sell because of the belief that the corporation has run out of opportunities for growth, thus causing them to look elsewhere in order to fulfill their investment goals. Of course, there are also plenty of shareholders who will collect the special dividend without doing much afterwards because their special nature means that they shouldn’t have much of an impact on the valuation of the shares. In the end, different reason for the special dividends can lead to very different outcomes, meaning that interested individuals need to pay close attention.