Stock dividends serve as a way for companies to reward investors without actually putting any cash in their pockets. From an accounting perspective, since no cash leaves the system, the total equity of the company remains the same. Unfortunately, this does not mean there is no effect on shareholders, and at times that effect may even be negative.
Mechanics of a Stock Dividend
From the investor's point of view, a stock dividend looks a lot like a stock split. Each investor receives a certain number of additional shares based on the amount they already hold. If a shareholder owns 100 shares and the company pays a 10 percent stock dividend, she will receive 10 new shares of stock. Since all shareholders receive the same dividend, they all continue to own the same portion of the company as they did before.
Stock Dividends on the Balance Sheet
On the balance sheet, a stock dividend shows up as a movement between accounting columns. First, the company deducts the market value of the shares issued for the dividend from the retained earnings column. Then, if the stock dividend is small -- less than 20-25 percent of the outstanding stock value -- the company makes a positive entry into two columns: one for the par value of the stock under "common stock" and one for the additional value under "paid in capital." Par value is a place holder -- often $1.00 per share -- so the majority of the stock value is placed into the "paid in capital" column. If the stock dividend is larger -- greater than 20-25 percent of the total outstanding stock value -- the total market value of the stock goes into the "common stock" column. Since each of these columns is added together to create the shareholders' equity, the net effect on equity is zero.
In some cases, shareholders experience the effects of stock dilution after a stock dividend. As noted, each investor receives more shares, but the overall value of the company has not changed. This can cause a decrease in the price of each share as the market accounts for the fact that each share represents a smaller proportion of ownership in the issuing company.
Stock vs. Cash Dividends
For investors, the value of stock dividends over cash dividends -- or no dividend at all -- is highly personal. Cash dividends mean an immediate return of value to the investor, and cash-in-pocket provides an opportunity for new investments, but cash dividends reduce shareholders' equity. No dividend means cash for company management to invest in the growth of the company itself, with increased share value as a likely outcome. Stock dividends are neither cash-in-hand or company reinvestment. They do, however, have a tax advantage over cash dividends. Cash dividends are always taxable as ordinary income. If the company only offers a stock dividend, it is a nontaxable event. This allows shareholders to choose when to pay tax -- they don't pay tax until they sell. In addition, the sale is taxed at the more favorable capital gains rate, rather than the ordinary income rate.