The Effects of Declaring and Paying Cash Dividends

by Sue-Lynn Carty

When a company declares a dividend, it is announcing to the public that it is paying its investors a dividend on a future date. When that date arrives, it is referred to as the payable date. Declaring a cash dividend can temporarily increase and decrease the stock price. Paying dividends can decrease a company’s assets.

Dividend Purpose

If a company has excess cash on hand and does not have any available investment opportunities that will potentially increase the value of the company, it often chooses to pay a cash dividend rather than add the cash to retained earnings. The choice to declare dividends often serves the dual purposes of rewarding the company’s investors and signaling to the markets that the company is fiscally strong and stable.

Increase in Stock Price

Companies announce the dollar amount of dividends payable per share on the declaration date. After this date, the stock price per share tends to increase. The amount of the stock price increase may vary, but it is typically in the dollar amount of dividends payable per share. For example, a stock was trading at $10 per share prior to a dividend declaration date of $1 per share. The stock price would increase to $11 per share to reflect the dividend declaration.

Decrease in Stock Price

The decreasing effect on stock price when a company declares a dividend occurs between the first ex-dividend date and the record date. The ex-dividend date is two trading days before the record date. The record date is the day the company does an official headcount of its shareholders on record. These shareholders will receive the cash dividend on the payable date. The stock price decreases when the markets open for trading on the first ex-dividend date. This occurs because the company has deducted the dividend payable per share per share from its current stock price.

Financial Statement Effects

When a company declares, but has not yet paid dividends, the company reports the amount of dividends as a decrease in retained earnings and an increase in the dividends payable liability account. When the company pays the dividends, it subtracts the payment from ending equity, resulting in a decrease in total stockholder’s equity. Dividends paid also appear in the financing activities section on the company’s Statement of Cash Flows.