Retained Earnings Effects With a Stock Split

by Robert Rimm, studioD

A typical stock split increases the number of issued and outstanding corporate shares and has minimal impact on retained earnings, which represent a company's surplus income after all expenses, dividends and special reserves. A decline in the stock price generally accompanies a split; if a company with a $100 stock declares a two-for-one split, twice as many shares will trade for $50 each. This is often considered a bullish move by managements and boards of directors eager to encourage broader company ownership amidst increased earnings.

Access to Capital Markets

Companies seeking to increase their visibility within the marketplace often wish to stimulate much wider corporate ownership. A business trading for $150 per share is generally less attractive to individual investors who can buy 10 times more stock in an equally appealing company selling for $15 per share. Private companies with plans to go public may choose to implement a split beforehand to ensure maximum participation with an eye toward increasing earnings in future quarters.

New Business Opportunities

Although a corporation's actual retained earnings do not increase or decrease with a stock split, making its shares more accessible is a key benefit if corporate strategy includes raising additional funds for expansion or takeovers. If, for example, the Green Corporation has the opportunity to increase its earnings by 20 percent with construction of a $100 million state-of-the-art warehouse and distribution facility, a lower share price makes raising those funds easier through a secondary stock offering. Nimble companies can take advantage of market opportunities as they arise and add to retained earnings.

Stockholders' Equity

While a stock split by itself does not change the total amount of retained earnings, both earnings per share and par value decrease. For example, the Emerald Company's earnings of $3 per share become $1 after a three-for-one split, while a previous par value of 75 cents per common share becomes 25 cents. (The par value is a nominal figure primarily for record-keeping purposes.) Concurrently, the number of shares owned by each stockholder of record triples as a result of the split, resulting in the same proportional ownership. A note in the Stockholders' Equity section of the balance sheet keeps these transactions straight.

Administrative Expenses

While a company's operations and immediate earnings are not generally affected by a stock split, legal, administrative and advertising expenses incurred as a result of the transaction can have the effect of reducing retained earnings. These costs are typically referenced in a footnote on the income statement and have minimal impact on overall corporate earnings. Prudent companies weigh all such factors and engage in such transactions opportunistically.

About the Author

Robert Rimm graduated from the University of Pennsylvania and founded to provide education, writing and communications services for clients within the nonprofit, arts and education communities in the United States, Europe and Russia. His key interests include art and culture, social entrepreneurship, education, the environment and human rights. He is fluent in French and Russian, and is a widely published author.