Why shareholders should be sceptical of “scrips”

By: Tim Bennett
Are free “scrip” shares a proper substitute for a cash dividend? Tim Bennett takes a look in this week’s video.

Why shareholders should be sceptical of “scrips”

A scrip issue (also known as a “bonus” or “capitalisation” issue, is a way for a firm to give shares to investors in lieu of a dividend. So, why do firms offer them and how good are they for shareholders?

Big business

There have been no shortage of Scrip dividends in recent years, as the following data from Redburn reveals;
Let’s take a quick look at how they work.

The basic mechanics

A shareholder would normally expect a dividend to be paid in cash. However, a firm that is short of cash may opt to offer an alternative in the form of scrip shares. These will usually represent a proportion of what would otherwise have been a cash dividend.
The above example has been simplified – for example in practice the formula used to calculate the number of scrip shares that will be offered is a bit more complex. That is less important here than the principle that a part of the dividend is being offered in free shares and that shareholders usually have a choice about accepting or rejecting the offer.

Why firms offer scrips

There are three main reasons, principle amongst which is a desire to save cash.

Why most shareholders accept

In one sense there is little point in turning down free shares but remember that these are being offered in place of cash. Besides, there are a few advantages to taking shares this way;

The not-so-good news

Whilst undoubtedly popular in Europe and in certain sectors, such as oil and gas, scrips are not unalloyed good news and often suit firms better than they do their shareholders.
Ultimately, shares and cash are not substitutes and a firm that gets used to offering shares instead of cash may lose the focus and discipline that cash dividends demand. Shareholders should therefore have clear sight on when the cash dividend will be reinstated in full.

Also the increase in the shares held is something of an illusion in so far as if the scrip shares are free, there will be no shareholder value added in terms of influence or portfolio size.
The conclusion? Scrip issues are part of the furniture in several sectors but that does not mean that shareholders shouldn’t challenge why they are being done and make sure that they understand the terms of a regular scrip program. To find out more, please contact an Investment Manager.