Types of Dividends

In some countries, companies can have dividend reinvestment plans (DRPs) that, at shareholders’ request, automatically reinvest all or part of the regular cash dividend by purchasing additional stocks. The additional stocks can be purchased in the open market (open market DRP) or can be newly issued (as in a new issue DRP, or scrip dividend scheme in the U.K.) by the company.

What are the advantages of a DRP?

• For the company, a DRP promotes a diverse shareholder base because DRPs provide a cost effective opportunity for retail investors to accumulate stock. DRPs also promote long-term investment. New issue DRPs allow companies to raise additional capital without the floatation cost of a secondary offering.
• DRPs offer shareholders a number of potential advantages. First DRPs generally allow for purchase of additional shares with no transaction costs. Second, DRPs allow shareholders to benefit from cost averaging. And third, the shares are sometimes offered to DRP participants at a discount to market price.

The main advantage of DRPs is that shareholders may have to cope with additional record keeping for tax purposes. Dividends reinvested at a market price higher than the original purchase price increase the average cost basis. Additionally, dividends are fully taxed in the year they are paid, even if they are reinvested. Therefore, it makes sense to hold DRPs in tax-sheltered accounts.

Extra or special (irregular) dividends

This is a cash dividend that supplements regular dividends or a dividend of a company that normally does not pay dividends, is known as a special dividend. Special dividends are paid under unusual circumstances (e.g., when the company sells off a division) under the expectation that the dividend is not recurring. 

Extra dividends may be paid if the company had an especially profitable year, but does not want to commit to a higher ongoing regular dividend payment.