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Why Do Companies Pay Stock Dividends? The Case of Bonus Distributions in an Inflationary Environment

Authors

  • Cahit Adaoglu,

    1. The first author is from the Department of Banking and Finance, Faculty of Business and Economics, Eastern Mediterranean University, North Cyprus. The second author is from Cass Business School, City University, London, UK. They thank Andrew Stark (editor), an anonymous referee, and participants at the 2008 Financial Management Association European Conference in Prague for their helpful comments and suggestions.
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  • Meziane Lasfer

    Corresponding author
    1. The first author is from the Department of Banking and Finance, Faculty of Business and Economics, Eastern Mediterranean University, North Cyprus. The second author is from Cass Business School, City University, London, UK. They thank Andrew Stark (editor), an anonymous referee, and participants at the 2008 Financial Management Association European Conference in Prague for their helpful comments and suggestions.
    Search for more papers by this author

Cahit Adaoglu, Department of Banking and Finance, Faculty of Business and Economics, Eastern Mediterranean University, Gazimagusa, Mersin 10, Turkey.
e-mail: cahit.adaoglu@emu.edu.tr

Abstract

Abstract:  We assess the market valuation of an unusual form of stock dividends, referred to as bonus distributions, which are carried out by transferring the accumulated equity reserves, mainly the inflation revaluation equity reserves, to paid-in capital leaving the total equity unchanged. In the absence of cash substitution and transaction cost effects, we find positive excess returns on the announcement dates, particularly for the financially weak firms, such as the non-cash-dividend-paying firms. We relate our results to the ‘paid-in capital hypothesis’ under which firms opt for bonus distributions to mitigate the impact of inflation on their eroding paid-in capital, to reduce their leverage defined as debt-to-paid-in-capital ratio, and to increase their credibility and borrowing capacity in a market of limited access to external equity financing. Although our results are also consistent with the retained earnings and signaling hypotheses, we find no support for the attention-getting, and a weak support for the liquidity enhancement hypotheses observed in other markets.

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