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    WordConjurer's Avatar
    WordConjurer Posts: 1, Reputation: 1
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    #1

    Jul 19, 2009, 04:51 PM
    Why decrease Retained Earnings?
    Would increased stockholder claims (as a result of issuing a stock dividend) decrease a company's retained earnings? I do understand that this strategy (issuing stock dividends) aims to drop the market value and increase the marketability of company stock. I am curious, does decreased retained earnings have the effect of lowering the market price for a company's stock?

    All things considered, retained earnings are what is left over after the owners... so if a company has more owners... they have less retained earnings, so would that it would be the cause of the drop in market value?
    ArcSine's Avatar
    ArcSine Posts: 969, Reputation: 106
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    #2

    Jul 20, 2009, 03:37 AM
    The market price of a company's stock is the total value the market places on a company's overall equity, spread over the number of shares outstanding. Thus, there's something of a disconnect between the market share price, and the company's book equity (including the book retained earnings).

    The reason that the share price drops as a result of a stock dividend is simply--holding all other factors constant--that the company's total equity value (as perceived by the market) is now spread over a greater number of shares. But note that the company's overall value remains unchanged.

    Suppose a company's equity is viewed as being worth $100, and it has 50 shares outstanding. The stock will thus be priced in the market at $2 per share. Now suppose the company issues another 30 shares via a stock dividend--i.e. it receives no cash for the new shares; its assets and liabilities are unchanged.

    The company is still worth 100 bucks overall, but with 80 shares now outstanding, each share will be priced in the market at $1.25. And of course, 80 shares, times 1.25 each, = $100--same total market value as before.

    All the foregoing simplifies things a bit by disregarding some of the wrinkles and market nuances that affect a stock's pricing. But you get the basic idea: It's not the change to retained earnings from a stock dividend that drops the stock price in the market, it's the company's overall market value being spread over a greater number of shares.

    I hope this was helpful. Check back in if you still have questions.
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