Dividends are the best known and most widespread means companies use to distribute a portion of their profits to their shareholders. However, there are other ways to reward shareholders, such as share buybacks.
Distribution of business earnings among shareholders is a common process for companies whose capital stock is divided into shares.
In a corporation whose shares are freely traded, the board of directors is the body in charge of designing and proposing the shareholder distributions policy and the specific form, amount and timing of each payment. After a given financial year has ended, the shareholders conduct a general meeting to ratify any interim distributions paid out earlier and approve the final appropriation of the profit or loss for the year: to be distributed to shareholders themselves, to compensate holders of other capital instruments, or to be allocated to reserves.
Here we review some of the main schemes available to companies for shareholder distributions:
The most common form of profit distribution by companies is dividends: cash payments, generally on a recurring schedule (quarterly, six-monthly or annual). These dividends are termed ‘ordinary’ dividends, since they are directly tied to the company's ongoing business and the earnings arising from it. Ordinary dividends can be of two kinds: interim or final. An interim dividend is a distribution paid in advance before the end of the financial year. A final dividend, however, is paid only once the appropriation of earnings for the year has been approved and the total distribution to shareholders has been determined. The final dividend payment is calculated as the difference between the amount paid out earlier as an interim dividend and the total shareholder distribution payable for the year.
When a company decides to pay a one-off dividend (usually triggered by an exceptional event, such as a realized gain on a corporate transaction) without the intention of continuing to do so on a regular schedule, the payment is termed a ‘special’ dividend.
Going beyond straight cash payments, the 'scrip dividend' approach lets shareholders choose between getting their reward in cash or in shares. Here, the company transfers to shareholders either shares from its treasury stock or rights of allotment, which can then be used to subscribe for shares arising from a capital increase, or simply sold for cash, either on the market or to the company itself.
Share buybacks are yet another way for companies to reward their shareholders. A share buyback program requires the company to buy a packet of its own shares, usually in the open market, and then retire (i.e., cancel) those shares. This form of compensation does not involve a return of shareholder funds. Instead, as there are fewer shares outstanding, each shareholder's stake in the company rises in value, thereby enhancing earnings per share (EPS).