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Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 38(5) & (6), 601627, June/July 2011, 0306-686X
doi: 10.1111/j.1468-5957.2011.02233.x

Why Do Companies Pay Stock Dividends?


The Case of Bonus Distributions in an
Inflationary Environment

CAHIT ADAOGLU AND MEZIANE LASFER

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.
Keywords: bonus distributions, bonus shares, stock dividends, paid-in capital, signaling,
retained earnings, liquidity, attention-getting

1. INTRODUCTION
Stock distributions either by stock splits or stock dividends are puzzling corporate
behaviour. In theory, these distributions are cosmetic operations aimed at dividing
the corporate pie into more pieces with no change in the total value of the firm.
However, previous empirical studies report a significant positive market reaction
on the announcement day, often related to a combination of signaling, liquidity,
attention-getting, and retained earnings hypotheses.1 This positive reaction is still
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. (Paper received January 2009, revised version accepted December 2010)

Address for correspondence: 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
1 See, for example, Grinblatt et al. (1984) and Rankine and Stice (1997) for the US evidence. Similar market
reactions are also detected in other markets such as Australia, Canada, China, Denmark, Germany, Greece,
Hong Kong, India, Japan, Korea and Switzerland (e.g., Balachandran et al., 2004; Kryzanowski and Hao,

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and 350 Main Street, Malden, MA 02148, USA. 601
602 ADAOGLU AND LASFER

controversial, as stock distributions can be substitutes to cash dividends (e.g., Baker


et al., 1995), and allow managers to conserve cash, implying that the market reaction
should be negative, since such distributions may exacerbate the Jensen (1986) free
cash flow problem and signal cash shortage.
In this paper, we examine the market valuation2 of an unusual form of stock
dividends called bonus distributions. We use the Istanbul Stock Exchange (ISE) as
a testing ground where firms distribute regularly bonus/free shares on a pro-rata basis
in an inflationary environment by using accumulated equity reserves, especially the
revaluation of assets reserve known as inflation revaluation equity reserves.3 This inflation-
adjustment of the book value of fixed assets allows companies to pay dividends, and
to fully utilize the tax shield advantage of depreciation expenses, and to avoid the
inflation taxation as well as the adverse effects of inflation on the paid-in capital. In
terms of accounting, these bonus distributions are transfers from the accumulated
equity reserves (i.e., equity reserves other than retained earnings) to paid-in capital.4
However, stock dividends, referred to in the UK as scrip dividends (Lasfer, 1997), are
transfers from distributable profit and/or retained earnings to paid-in capital. Overall,
both bonus distributions and stock dividends do not change the amount of total equity,
but only change its composition. Since bonus distributions are not financed from
retained/distributable profit, and the transaction costs are based on the total amount
of the transaction rather than on the total number of shares, they are not affected by
the cash substitution and the transaction costs considerations.
Unlike market-oriented countries such as the UK and the US, the amount of
paid-in capital has more legal as well as corporate policy implications in bank-oriented
countries such as Turkey, Germany, Denmark and Switzerland (Booth et al., 2001;
Wulff, 2002; Bechmann and Raaballe, 2007; and Kunz and Rosa-Majhensek, 2008).
From an accounting perspective, stock dividends are significantly different from stock
splits. By reducing the par value of shares, stock splits do not change the amount of
paid-in capital and do not change the capital structure. However, stock dividends allow
firms to transfer retained earnings to paid-in capital, increasing the amount of paid-in
capital, and specifically, changing the equity composition of capital structure.
Similar to the increase in paid-in capital through stock dividends, bonus distribu-
tions also change the equity composition of capital structure and increase the paid-in
capital with a higher number of shares having the same par value as the old shares.
Consequently, bonus distributions have significant implications on the dividend policy
and on the debt financing capacity. The paid-in capital is a legally nondistributable
equity item and has a higher legal protection than the other distributable equity
items, which the controlling shareholders, typically family members in Turkey, can
abuse (Demirag and Serter, 2003). Specifically, the amount of paid-in capital has direct

1991; Barnes and Ma, 2004; Bechmann and Raaballe, 2007; Wulff, 2002; Leledakis et al., 2009; Papaioannou
et al., 2000; Wu and Chan, 1997; Lukose and Rao, 2002; Kato and Tsay, 2002; Dhatt et al., 1997; and Kunz
and Rosa-Majhensek, 2008).
2 We examine the announcement market reaction to test our hypotheses. See Anderson et al. (2001 and
2004) for the ex-day effect of stock dividends and the impact of taxes.
3 Papaioannou et al. (2000) document a similar corporate practice in Greece due to high levels of inflation
during the 1970s.
4 In other prominent emerging markets such as China, India, Australia and Greece, the classification of
stock distributions is mixed, and bonus distribution (bonus stock or bonus issue) is the term used for
all free issues of shares from accumulated capital reserves and/or retained earnings/distributable profit.
However, in Turkey, the distinction between stock dividends and bonus distributions is made clear for
investors.


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implications on the borrowing capacity since listed firms in the ISE can only issue debt
up to 600% of their paid-in capital (Muradoglu and Aydogan, 2003). In regards to
the dividend policy implication, bonus distributions can signal better future earnings
and future cash dividends at least proportionally to the increase in paid-in capital in
order to maintain the same cash dividends per share in a desired stable dividend policy
environment.5
Finally, we strengthen the corporate policy implications of the amount of paid-in
capital by analysing the prospectuses of ISE companies where we find that directors
state bonus distributions will increase the amount of paid-in capital in almost all
announcements.6 In the ISE, such announcements appear to convey good news
to the existing shareholders, particularly given the settings of high inflation, weak
shareholder but high creditor rights framework, closely held market structure, heavy
reliance on bank financing as corporate bond market is unavailable, and limited access
to external equity financing.
We first analyze all the 1,326 bonus distributions by non-financial firms over the
period 1986 to 2006. We find that the number of bonus distributions follow the
inflation index, increasing monotonically from 20 in 1986 to 97 in 1995, as the
inflation rate rose from 35% to 106%, and then decreasing to 31 in 2006, as inflation
decreased progressively to single digit rates. The implementation of international
inflation accounting standards in 2004 is likely to have also contributed to the sharp
decline, particularly in 2005 and 2006. We then focus on the market reaction to the
announcement of such distributions using the standard event study methodology.
Our sample is limited to 371 announcements over the period 19952006, as the ISE
established a formal mandatory process of news announcements only in late 1994.
We find positive and statistically significant average abnormal returns of 1.49% (t =
8.44) on the announcement day 0, and 0.94% (t = 5.33) on day +1. We also report
that the pre-event period cumulative abnormal returns, CAR5,1 , are positive and
significant, but the post-event period, CAR+2,+5 , are negative but not significant. We
obtain relatively similar results when we use a sample of 157 and 213 events with no
confounding events over the 5 to +5 and 1 to + 2 periods, respectively, except that
both the pre- and post-event period CARs are positive, but not significant.
We assess the drivers of such positive event period abnormal returns by focusing
mainly on the paid-in capital hypothesis underlined within the ISE institutional
setting. We argue that in the case of Turkey where inflation is high and the access
to external equity financing is limited, firms are more likely to recur to bonus
distributions as the high level of inflation erodes their paid-in capital, increases their
book-value of leverage measured by debt-to-paid-in-capital ratio, and reduces their
credibility and borrowing capacity. We also test the previously documented hypotheses,
namely the retained earnings, signaling, liquidity, and attention-getting hypotheses.
Our results provide strong support for the paid-in capital hypothesis. In particular,
we find that both the market reaction and the bonus distribution ratios are positively

5 Moreover, in bank-oriented markets such as Denmark and Turkey, the commercial code dictates that a
company cannot pay out cash dividends if the amount of paid-in capital is less than the book value of equity.
Especially in Denmark, cash dividend distributions are strictly constrained by the amount of paid-in capital
(Bechmann and Raaballe, 2007). In market oriented countries, such as the US, the amount of paid-in capital
is a soft or not a constraint on the dividend policy (Crawford et al., 2005).
6 Similarly, in Denmark, as required by the listing requirements, 67% of Danish firms distributing stock
dividends declare the primary motivation as improving the paid-in capital (Bechmann and Raaballe, 2007).


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related to debt-to-paid-in-capital ratio. In addition, we find a significantly higher


market reaction for non-dividend payers of 4.40% compared to 1.18% for dividend-
paying firms, in line with Grinblatt et al. (1984) and Nayak and Prabhala (2001).
Previous studies refer to such difference in the market reaction as a puzzle. We provide
evidence that the non-dividend-paying firms are more likely to benefit from bonus
distributions under our paid-in capital hypothesis, as they are smaller, less profitable,
and have lower growth opportunities, and have higher financial leverage (i.e., in terms
of both debt-to-paid-in-capital and debt-to-equity ratios) than dividend-paying firms.
Our results suggest that bonus distributions allow these non-dividend-paying firms to
increase their amount of paid-in capital as a stronger covenant and to sustain their
debt financing in a heavily debt oriented capital market. Our results also imply that
companies use bonus distributions as a financial policy tool to gain more credibility
in an inflationary environment for the continuity of their debt financing, even though
bonus distributions affect negatively the wealth of existing shareholders by providing
more security for debtholders in terms of a larger amount of legally nondistributable
paid-in capital.7 In our regression results, we find that the improvement in paid-in
capital is more important and imminent for non-dividend-paying firms in a market of
limited access to external equity financing.
We also test the liquidity effect and find mixed evidence, in line with previous
studies in developed markets (e.g., Copeland, 1979; Lakonishok and Lev, 1987;
Conroy et al., 1990; Han, 1995; Wulff, 2002; Elfakhani and Lung, 2003; Bechmann
and Raaballe, 2007; Guo et al., 2008; and Kunz and Rosa-Majhensek, 2008). Our
univariate analysis of the various measures of liquidity, including the adjusted trading
volume, the relative trading volume, the market depth ratio, the number of positive
volume-zero return days, and the share turnover, provide support for the enhanced
liquidity, but only for firms with the lowest liquidity prior to the announcement. We
find no evidence for the attention-getting hypothesis as the abnormal returns are
not related to firm size. We show that the market reaction is significantly higher
in 20052006 when the inflation rate is very low, and the signaling through bonus
distributions is stronger. We also find some evidence that the market reaction is
higher for firms that underperformed in the previous six months before the bonus
distribution announcement, suggesting that firms make such announcements to signal
future recovery.
Previous studies focus on the differences in the positive announcement effects of
two forms of stock distributions; stock splits and stock dividends. For example, Grin-
blatt et al. (1984) and Rankine and Stice (1997) for the US market, and Bechmann
and Raaballe (2007) for the Danish market show that stock dividend announcements
result in a higher returns, consistent with the retained earnings hypothesis.8 Under
this setting, we focus on whether bonus distributions also convey a positive signal that
the increase in the number of shares, and the reduction in the pool of distributable
reserves, will not negatively affect future dividends. Our regression results provide

7 Bechmann and Raaballe (2007) also find for the Danish companies that even though the share capital
(paid-in capital) increases improve the security for creditors at the expense of the shareholders, it is a
needed company decision in order to sustain the debt financing and finance growth.
8 The intimate relationship between the dividend policy and stock dividends/stock splits had been
established in the prominent study by Fama et al. (1969) and later, had been investigated progressively in
more detail by Grinblatt et al. (1984), Rankine and Stice (1997), Nayak and Prabhala (2001) and Crawford et
al. (2005) for the US market. Similarly, Liljeblom (1989) examines the relationship for the Swedish market,
and Bechmann and Raaballe (2007) for the Danish market.


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support for the positive effect of dividend changes on the market reaction, even after
controlling for other factors.
The rest of the paper is structured as follows. Section 2 presents the theoretical back-
ground and sets up the hypotheses. Section 3 presents the data and the methodology.
Section 4 reports the empirical results, followed by the conclusions in Section 5.

2. THEORETICAL BACKGROUND

(i) Review of the Literature


Previous studies relate the stock distributions to five main hypotheses; (i) signaling,
(ii) enhanced liquidity, (iii) attention-getting (neglected firm), (iv) retained earnings,
and (v) cash substitution hypotheses. The signaling hypothesis states that, in the
presence of asymmetric information, firms distribute free shares to signal optimistic
expectations to investors, namely, larger increases in future earnings, in order to at
least maintain or increase their cash dividends and earnings per share. This hypothesis
is widely supported by the predominately US findings of positive market reaction to
stock distributions.9
The enhanced liquidity hypothesis suggests that the increase in the liquidity and
marketability of the stock explains the positive abnormal returns, as stock distributions
increase the number of shares in circulation, and result in a decrease in the bid-ask
spread. The other form of enhanced liquidity is the trading range hypothesis, which
states that the main motivation behind stock distributions is to move the stock price
into a normal or optimal trading range to attract more investors, and hence, increase
liquidity. However, the empirical evidence on the liquidity effect in the US is mixed
and inconclusive (e.g., Copeland, 1979; Murray, 1985; Lakonishok and Lev, 1987;
Lamoureux and Poon, 1987; Conroy et al., 1990; McNichols and Dravid, 1990; and
Ikenberry et al., 1996). In line with these arguments, the attention-getting hypothesis
states that managers, who believe that the stock is currently undervalued, use the stock
distributions to attract the attention of analysts who are likely to revalue their future
cash flows (Grinblatt et al., 1984; and Arbel and Swanson, 1993).
The remaining two hypotheses focus on the firms dividend policy. The retained
earnings hypothesis relates the differences in the magnitude of positive market
reaction to the two forms of free stock distributions, namely stock dividends and
stock splits. This hypothesis states that stock dividends incorporate stronger signals as
they decrease the pool of distributable funds implying that managers believe in strong
future cash flows in order to have a stable dividend policy (Rankine and Stice, 1997;
Crawford et al., 2005; and Bechmann and Raaballe, 2007). This hypothesis considers
that stock splits do not change the capital structure, but stock dividends change the
equity composition of capital structure because of the transfer of retained earnings
to paid-in capital, thus decreasing the amount of distributable reserves. Consequently,
Grinblatt et al. (1984) and Rankine and Stice (1997) argue that stock dividends are
costly signals. Thus, in line with the previous hypotheses, stock dividends should result
in a higher positive market reaction. In contrast, the cash substitution hypothesis

9 See, for example, among others, Nichols (1981), Grinblatt et al. (1984), McNichols and Dravid (1990),
Woolridge (1983), Banker et al. (1993), Peterson et al. (1996), Rankine and Stice (1997), Elfakhani and
Lung (2003) and Guo et al. (2008).


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predicts a negative market reaction on the announcement date, because managers


keep the cash in the firm, thus increasing the free cash flow problem, and at the
same time, satisfy the shareholders by distributing free shares, thus reducing the
monitoring role of shareholders.

(ii) Hypotheses
In our paper, we expect bonus distribution announcements to lead to positive market
reaction. However, we expect different explanatory factors than those previously
documented in previous studies. The ISE settings allow us to develop an alternative
hypothesis. Bonus distributions change the equity composition of capital structure by
increasing the paid-in capital, providing better protection for creditors and adversely
affecting the existing shareholders. Even though the proportional increase in paid-
in capital favours debtholders, who are more secured at the expense of existing
shareholders, shareholders welcome the paid-in capital increases in Turkey.
Gonenc (2003) shows that due to high inflation, and political and economic
uncertainty in Turkey, the average long-term leverage of Turkish firms of 12% over the
period 19901999 is relatively low. In these economic conditions, it is very difficult to
find external equity, and firms need bank financing, especially short-term financing, to
support their growth. Interestingly, unlike the negative relationship in developed and
some developing countries (e.g., Booth et al., 2001), Gonenc (2003) finds a positive
relationship between the growth opportunities and leverage. In the ISE settings, bonus
distributions increase the paid-in capital and hence, increase the borrowing capacity
especially considering the debt issue limits being directly related to the amount of
paid-in capital. These arguments suggest the following paid-in capital hypothesis:
H1 : In an inflationary environment, the size of the bonus distribution is expected
to increase with the debt-to-paid-in-capital ratio, and its improvement will be
positively related to the announcement date market reaction.
Previous studies report a strong relationship between stock dividends/stock splits
and cash dividend policy. For example, Grinblatt et al. (1984) find that the magnitude
of the market reaction to the collective sample of pure stock dividend or stock split
announcements of non-dividend-paying firms is higher than that of dividend-paying
firms. Nayak and Prabhala (2001) suggest that the conditioning of the level of market
reaction to stock splits on the firms dividend paying status is an unresolved puzzle.
They propose two, not mutually exclusive, hypotheses contribute to explaining the
positive difference in market reaction between the non-dividend payers and dividend
payers. The first is the differential expectations hypothesis, which states that non-
dividend-paying firms might be less likely, a priori, to announce a stock split because
they are likely to be younger, have higher growth, and are more volatile than stable
dividend-paying firms. However, the market will be surprised if they announce stock
splits, resulting in a higher reaction. The second is the informational substitute
hypothesis, which states that the splits and cash dividends are informational substitutes
to each other, and any unexpected information in a split announcement is less
informative resulting in a lower market reaction for dividend-paying firms. In the ISE
settings, we argue that non-dividend-paying companies are likely to have higher paid-
in capital erosion with a greater adverse effect on their borrowing capacity. Therefore,
bonus distributions will allow them to distribute free shares to their shareholders


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and increase their paid-in capital and borrowing capacity. These arguments suggest
the following hypothesis:
H2 : The market reaction to bonus distribution announcements is higher for non-
dividend-paying firms because of the relatively higher impact of inflation on
their paid-in capital and borrowing capacity.
Since bonus shares in the ISE are distributed frequently on a pro-rata basis using
accumulated equity reserves not including the retained earnings, their decision is not
likely to be a cash conserving strategy, thus it cannot be related to the cash substitution
hypothesis. Moreover, since the magnitude and frequency of bonus distributions10 are
significantly large, firms in the ISE are unlikely to time them, thus, weakening the
signaling effect. In addition, the closely held ownership structure, especially family
controlled firms in the ISE,11 diminishes the need to use bonus distributions as a
signaling device.12 For a signaling device to be valid, both the direct and indirect
costs associated with sending a false signal, the resulting administrative costs and
the increased transaction costs for investors, should be sufficiently high so that bad
companies cannot mimic the decision. The brokerage commission in the ISE is based
on the total market value of the transaction, not on the number of shares traded as in
the US. Consequently, bonus distributions do not alter the transaction costs incurred
by Turkish investors, and the administrative costs of frequent distributions are low.13
However, in the ISE, the high frequency of bonus distributions may result in a high
indirect cost of sending false signals due to repeated game, resulting in sufficiently
high total costs.14
Even though ISE firms do not distribute bonus shares by using retained earnings,
we reinterpret the retained earnings hypothesis, developed in previous studies, within
the unique ISE settings where bonus distributions can signal better future earnings
and future cash dividends, at least proportionally to the increase in paid-in capital,
in order to maintain the same cash dividends per share. This is particularly the case
since bonus distributions are large, and are likely to result in large increases in the
number of shares, making it difficult for companies to maintain their dividends per
share. Similarly, in other markets, stock dividends increase the paid-in capital, and they
are costly signals resulting in better future earnings expectation in order to maintain
at least the same level of dividends per share (Grinblatt et al., 1984; Rankine and
Stice, 1997; Crawford et al., 2005; and Bechmann and Raaballe, 2007). Focusing on
the increase in paid-in capital, Bechmann and Raaballe (2007) provide support for
the retained earnings/signaling hypothesis, and find a statistically significant stock
price effect for Danish firms announcing stock dividends with a split factor less than
two. These firms can afford to increase their cash dividends at least proportionally

10 We find that for the period 19862006, on average, ISE companies have two bonus distributions every
five years of trading.
11 Demirag and Serter (2003) show that the ownership of Turkish companies is highly concentrated,
families being the dominant shareholders.
12 Similarly, the settings in Germany and Greece limit the ability of companies to use stock distributions for
signaling (e.g., Wulff, 2002; Papaioannou et al., 2000; and Leledakis et al., 2009).
13 Kamiler (2006) shows that the direct costs of bonus distribution, such as approval fees and accounting
fees, are around 0.5% of the amount of the distribution, and are low. ISE firms typically decide on the bonus
distribution at the AGM together with other essential decisions and rarely have extraordinary shareholder
meetings for the bonus distribution decision.
14 We would like to thank the anonymous referee for pointing out the indirect cost of sending false signals,
particularly the repeated game factor.


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to the increase in their paid-in capital. However, Danish firms that announce stock
dividends with split factors of two or more do not generate statistically significant
positive excess returns, since the magnitude of increase in cash dividends for these
firms is not sufficient enough to match the magnitude of increase in paid-in capital.
In the ISE settings, the market reaction to bonus distributions is also likely to reflect
the liquidity effect, as the market is typically driven by short-term investors (e.g., Bildik
and Gulay, 2007), and the lack of long-term institutional investors makes the market
very volatile. Based on the observations of low diffusion of ownership and an average
public openness (free float) of 24% in the ISE, financial practitioners argue that
shareholders welcome bonus distributions, since they increase the number of shares
in circulation resulting in enhanced liquidity and marketability. Moreover, bringing
the stock price into an optimal trading range can be another motivation for bonus
distributions, particularly given the significant growth in the ISE index during our
sample period. Finally, within the framework of attention-getting, bonus distributions
can also be used as a tool to attract analysts attention. Overall, these arguments suggest
that the market reaction on the announcement date is likely to be consistent with
the retained earnings/signaling, enhanced liquidity, and attention-getting hypotheses.
We, therefore, set the following hypothesis:
H3 : The market reacts positively to bonus distribution to reflect the degree of
retained earnings/signaling, liquidity enhancement and attention-getting
considerations.

3. DATA AND METHODOLOGY


We collect all stock distributions from the ISE database ISE Companies Capital Increases
and Dividend Payments 19862007 . We exclude financial and utility firms because they
have different investment and dividend policies, and they are subject to different
regulatory regimes. We obtain 1,326 bonus distributions. We then search through the
official ISE daily bulletins in the electronic news database of Finnet Haber Analiz
4.0C over the period 1995200615 to extract the announcement dates for bonus
distributions which are not accompanied by rights offerings and/or stock dividends
in the event year. We start with 430 bonus distributions and exclude the following
distributions: eight with missing announcement dates, nine related to mergers and
acquisitions, three not announced by the board of directors,16 28 with insufficient
price data for the estimation period due to being newly listed, and 11 outliers with
bonus distribution ratio greater than 1,000%. Our final sample includes 371 bonus
distribution announcements.
We base our analysis on three main samples. The first includes the whole sample
of 371 observations, but this sample may suffer from contamination problems with
other news announcements. Therefore, we create two additional samples that exclude
confounding events, as companies announce bonus distributions at the same time as
earnings, rights offerings and other confounding news, first, over the 5 to +5 period,

15 The official ISE daily bulletins published in 1995 and after are used since the mandatory information
disclosure requirements and standards have been introduced during the second half of 1994 by the Capital
Markets Board, the capital markets regulatory body in Turkey.
16 All bonus distribution announcements are typically declared by the board of directors just after their
meeting. There are very few bonus distribution announcements in conjunction with the decisions taken in
the annual general meeting or with the application for registering the shares.


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and second, following Grinblatt et al. (1984), over the 1 to +2 period relative to the
announcement date. Our respective samples are 157 and 213 uncontaminated bonus
distribution announcements. We collect the adjusted and unadjusted stock prices,
trading volume and financial ratios for the period 19942007 from the electronic
databases Finnet Mali Analiz 3.0C and Rasyonet Hisse XL v.2.3.2C software.
We use the standard event study methodology, namely the market-adjusted model,17
to assess the market reaction to bonus distribution announcements, with the estima-
tion period ranging between 140 to 2118 days and the event window from 5 to
+5 days relative to the announcement day. We focus on three periods, namely the
pre-event period 5 to 1, the event period 0 to +1, and the post-event period +2
to +5. We use the value-weighted ISE 100 index, which includes 100 firms based on
their market value and liquidity characteristics, as a proxy for the market portfolio.
The ISE 100 index is a representative index and is the most widely used index by
the investment banking industry as well as by the financial researchers as a proxy
for the market return, and its data is available for the period of our analysis. We use
the non-parametric generalized sign test as a robustness check in order to avoid the
dependence on normality of return distributions.
After the analysis of the event period market reaction to bonus distributions,
we use the univariate analysis to assess whether bonus distributions are driven by
firms fundamental characteristics that reflect the erosion in paid-in capital. We follow
previous studies and focus on the differences in market reaction to bonus distributions
between dividend-paying and non-dividend-paying firms. We expect the non-dividend-
paying firms to be affected more by the erosion of paid-in capital and to have a higher
market reaction. We, therefore, compare the profitability defined as operating profit
margin, financial leverage as measured by Debt/Equity, Paid-in Capital/Equity, and
Debt/Paid-in Capital, growth potentials proxied by Market-to-Book, size defined as
the market value of equity, and finally, the level of unadjusted stock price. ISE non-
financial firms are heavily dependent on borrowing and are likely to be affected
significantly by the decrease in the real value of paid-in capital in an inflationary
environment. We provide evidence as to whether firms increase the paid-in capital
to finance growth by borrowing or to maintain their debt financing.
In the univariate analysis, we also assess the liquidity enhancing effects. We cannot
measure liquidity of stocks by bid-ask spreads in the ISE, since there are no market
makers or specialists who post bid and ask prices. In the ISE, investors provide liquidity
to the market by entering their limit orders into the electronic trading system, and they
act as market makers. They do not have to hold stock inventories in the ISEs price
competitive and order-matching trading system (multiple price continuous auction
system). Instead, we use the traditional daily share turnover ratio defined as the ratio
of unadjusted volume in lots over shares outstanding. None of the firms in our sample
has missing daily trading data.
17 Two other models, namely the market model and mean adjusted models, are also used for measuring the
market reaction. The test results are quantitatively and qualitatively similar to those reported in the paper.
Additionally, none of the stocks in the sample has missing trading price data eliminating the non-trading
problem in event studies.
18 Bechmann and Raaballe (2007) show that stock dividends and stock splits are typically implemented
after a period of stock price increase leading to potential bias in using the pre-event estimation period; they
use a post-event estimation window. For our sample, the cumulative abnormal return for the estimation
period (140, 21) is statistically insignificant and in the Turkish setting, more biases will be introduced by
using a post-estimation period due to possible effects of the stock delivery (ex-day) which is on average 69
trading days apart for our bonus distributions sample.


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610 ADAOGLU AND LASFER

We also use the stocks adjusted trading volume, relative trading volume, market
depth ratio, and the number of positive volume-zero return days19 (Han, 1995; Amihud
et al., 1997; Lesmond et al., 1999; and Bekaert et al., 2007) as yardsticks for robustness
checks. Previous studies (e.g., Amihud and Mendelson, 1986) show that stocks trading
volume is an increasing function of its liquidity, ceteris paribus, and, thus, an increase
(decrease) in the trading volume will reflect an increase (decrease) in liquidity. In
addition, we use the average relative trading volume, defined as the average unadjusted
trading volume divided by the average market volume for each period. Other market
microstructure studies (e.g., Khan and Baker, 1993; Berkman and Eleswarapu, 1998;
and Muscarella and Piwowar, 2001) suggest the market depth ratio, which measures
the adjusted trading volume associated with a unit change in the adjusted stock price.
A high ratio indicates that investors can trade a large number of shares with little price
change. Therefore, an increase (decrease) in the liquidity ratio will be reflected in an
increase (decrease) in market depth, defined as:


m
Vi,t
MDik,m =
k
m   (1)

Ri,t 
k

where Vi,t and |Ri,t | are the adjusted trading volume and the absolute return respec-
tively for security i on day t.
For emerging markets, Lesmond et al. (1999) and Bekaert et al. (2007) suggest the
number of days of positive volume-zero return as a proxy for liquidity. In the setting
of no missing daily trading volume, stocks with lower liquidity are more likely to have
zero-return days. Goyenko et al. (2009) state that:

. . .stocks with higher transaction costs have less private information acquisition (because
it is more difficult to overcome higher transaction costs), and thus, even on positive
volume days, they are more likely to have no-information-revelation, zero-return days
(p. 159).

For each of these measures, we define the change in liquidity as the difference
between the pre-announcement period (260 to 21) and the post-ex-day period
(+21 to +260) levels. In addition, Wulff (2002) shows that less liquid shares have a
relatively larger improvement in liquidity and a stock split does not improve liquidity
if the stocks liquidity is already high for the German stock splits. Therefore, we divide
our sample into three groups in ascending liquidity order for the five measures of
liquidity. The statistical significance of mean and median changes for all and sorted
groups is tested using the parametric paired t-test and the non-parametric Wilcoxon
test.
We then use regressions to assess the combined effects of our defined hypotheses.
First, we analyze the determinants of the bonus distribution ratio, BDR. Building
on the models by McNichols and Dravid (1990) and Nayak and Prabhala (2001),
we use the following regression model to capture the factors that determine the
market expectations of the forthcoming bonus distributions, based on the markets

19 We would like to thank the editor for suggesting this alternative liquidity measure in the setting of no
missing daily trading volume.


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WHY DO COMPANIES PAY STOCK DIVIDENDS? 611

information prior to the bonus distribution announcement:

BDRi = 0 + 1 Pi + 2 MVi + 3 DPCi + 4 STi + 5 RUNUPi + i (2)

where BDR, the bonus distribution ratio, is defined as the amount of bonus distri-
butions divided by the amount of paid-in capital, and it is equivalent to the number
of bonus shares divided by the number of outstanding shares since bonus shares are
issued at the same nominal value of old shares. P is the natural log of unadjusted
stock price at the end of quarter before the bonus issue announcement. MV is the
natural log of market value of equity at the end of the quarter before the bonus
distribution announcement. DPC is the debt-to-paid-in-capital ratio at the end of
fiscal year before the bonus distribution announcement. ST is the average daily share
turnover during the pre-announcement period (260, 21). Finally, RUNUP is the
cumulative abnormal return for the pre-announcement period (140, 21).
We expect a positive relationship between BDR and DPC, since a higher bonus
distribution is needed to bring down the leverage, measured by debt-to-paid-in-
capital ratio, to a reasonable level under the paid-in capital hypothesis, and a positive
relationship between BDR and P, since firms with high stock prices are more likely to
have bonus distributions. Based on the finding of Stoll and Whaley (1983), McNichols
and Dravid (1990) argue that larger firms prefer to maintain a higher stock price
(i.e., a higher targeted stock price) indicating a negative relationship between BDR
and MV. Following Nayak and Prabhala (2001), we add share turnover, ST, to capture
the association between the bonus distributions and the pre-announcement trading
volume. We also include RUNUP since firms with unusual increases in stock prices are
more likely to have bonus distributions.
Second, we analyze the drivers of the announcement date excess returns, CAR(0,+1) .
We follow Grinblatt et al. (1984) and Rankine and Stice (1997), and use the following
two regression models:

CAR(0,+1),i = 0 + 1 BDRi + 2 INFi + 3 STLOWi + 4 NPi + i (3)

CAR(0,+1),i = 0 + 1 DPCi + 2 Pi + 3 MVi + 4 STi + 5 RUNUPi


+ 6 INFi + 7 STLOWi + 8 NPi + i (4)

where, in addition to the variables included in equation (2), we add three dummy
variables: INF, a dummy equal to 1 for firms with bonus distributions in 2005 and/or
2006, when the international inflation accounting standards are implemented and
Turkey had single digit inflation rates; STLOW and NP, two dummies equal to 1 if the
firm is in the lowest share turnover group, and does not pay cash dividend in the event
year (non-dividend payer), respectively. These two models also allow us to overcome
the endogeneity problem.
Our hypothesis H1 suggests a positive relationship between CARs and BDR, as the
higher the distribution ratio, the higher the improvement in the paid-in-capital, and,
thus, the higher the positive market impact. Similarly, we also expect the coefficient
of non-dividend-paying firms dummy, NP, to be positive, following hypothesis H2 .
Hypothesis H3 suggests a positive relationship between CARs and STLOW dummy
to reflect the liquidity impact, but a negative relationship between CARs and MV to


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612 ADAOGLU AND LASFER

reflect the attention-getting hypothesis, as small firms tend to be followed less by fi-
nancial analysts. Similarly, the relationship between CARs and the pre-announcement
share turnover, ST, will be negative, as the higher the pre-announcement share
turnover, the lower the enhanced liquidity effect. Moreover, CARs will be negatively
related to RUNUP reflecting the possibility that market participants have already
anticipated the announcement of bonus distributions, in line with Grinblatt et al.
(1984), McNichols and Dravid (1990) and Rankine and Stice (1997). We also include
a dummy variable, INF, to assess the impact of the implementation of international
inflation accounting standards and the single digit inflation levels in 2005 and 2006.
However, the expected relationship between CARs and the unadjusted stock price,
P, before the announcement is not clear. According to the optimal trading range
hypothesis, a firm with a high stock price is more likely to have bonus distributions and
hence, may result in a positive relation between the market reaction and the level of
stock price with the expectation of bringing the stock price to a more optimal level for
liquidity. However, following Rankine and Stice (1997), it is also likely that firms with
high stock prices are more anticipated by the market to declare a bonus distribution,
and, thus, the market will react less, implying a negative relationship.
We follow Grinblatt et al. (1984) and control for the effects of cash dividend pay-
ment status (i.e., retained earnings/signaling hypothesis) by including two additional
control variables; the change in the adjusted dividends per share in the event year,
PDIV, and the change in the adjusted dividends per share subsequent to the event year,
SDIV. These two measures will assess whether firms provide information to the market
about their potential dividend change when they announce bonus distributions.

4. EMPIRICAL RESULTS

(i) Bonus Distributions and Inflation


Figure 1 shows the relationship between the number of bonus distributions and the
consumer price inflation for all the 1,326 bonus distributions by non-financial firms
over the period 19862006. The figure shows that between 1986 and 2003 when the
inflation rate was mostly above 20%, the number of bonus distributions followed
the inflation trend. However, in 2005 and 2006, the number of bonus distributions
decreased sharply.20 This is mainly due to the decrease in the inflation rate to a single
digit and the implementation of international inflation accounting standards starting
in the fiscal year 2004, when the accounting standard setters abolished the inflation
revaluation of assets, and, instead, introduced the paid-in capital inflation adjustment
reserve.
Table 1, Panel A provides the descriptive statistics of the annual distribution of
the number of bonus distributions for our samples. In line with Figure 1, the annual
distribution of our samples follows the same trends with significant declines in years
2005 and 2006, when the bonus distributions became less popular, as the inflation rate
declined significantly. This trend is relatively similar across our two non-confounding
samples.

20 Even though the inflation rate in 2004 is relatively low, the sharp decrease in the number of bonus
distributions does not start in 2004 since the bonus shares in 2004 are distributed from the inflation
revaluation equity reserves of fiscal year 2003.


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WHY DO COMPANIES PAY STOCK DIVIDENDS? 613

Figure 1
Number of Bonus Distributions and Consumer Price Inflation (1986 to 2006)
120 120%

100 100%
Number of Bonus Distributions

Consumer Price Inflation


80 80%

60 60%

40 40%

20 20%

- 0%
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Year

Number of Bonus Distributions Consumer Price Inflation

Panel B shows the distribution of our samples, sorted by the bonus distribution
ratio, i.e., bonus distributions over paid-in capital (BDR). The results indicate that
52% of bonus distributions are within 1% to 100% BDR, 33% are between 101% and
300%, and 15% are above 301%. We find very few that reach 1,000%. We obtain similar
results when we consider the sample with non-confounding events over the 5 to +5
and 1 to +2 periods. Overall, the aggregate average of BDR of 175% is substantially
higher than the averages in other markets such as 100% in India, 69% in Greece, 30%
in China, 18% in Australia, 11% in US, and 9% in Japan. However, our average BDR
is lower than 245% for stock dividends in Denmark, with similar market settings and
motivations as in Turkey (Lukose and Rao, 2002; Papaioannou et al., 2000; Barnes and
Ma, 2004; Balachandran et al., 2004; Lakonishok and Lev, 1987; Kato and Tsay, 2002;
and Bechmann and Raaballe, 2007).

(ii) Market Reaction to Bonus Distributions Announcements


Table 2 presents the daily mean abnormal returns and the percentage of positive daily
mean abnormal returns along with the t-value, and the generalized sign test result.
The results indicate that share prices increase abnormally by 1.49% (t = 8.44) on day
0 and by 0.94% (t = 5.33) on day +1. The daily mean abnormal returns in the pre-
event and post-event periods are not statistically significant, except for day 2 when
share prices increase abnormally by 0.47% (t = 2.66). We replicated these results using
the non-contaminated samples and find similar results. For example, using the 213
announcements with no confounding news over 1 to +2 days, we find no excess
returns in the pre- and post-event period, with the exception of 0.4% (t = 1.83) on day


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614
Table 1
Descriptive Statistics for Bonus Distributions
Panel A: Annual Distribution of Our Samples
Years 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

All 12 21 26 29 41 26 42 39 43 55 24 13
% of Total 3.23 5.66 7.01 7.82 11.05 7.01 11.32 10.51 11.59 14.82 6.47 3.50
Non-confounding (1,+2) 10 12 17 18 25 14 27 22 26 28 11 3
% of Total 4.69 5.63 7.98 8.45 11.74 6.57 12.68 10.33 12.21 13.15 5.16 1.41
Non-confounding (5,+5) 6 8 8 16 21 12 21 17 21 19 5 3

ADAOGLU AND LASFER


% of Total 3.82 5.10 5.10 10.19 13.38 7.64 13.38 10.83 13.38 12.10 3.18 1.91

Panel B: Distribution of All Announcements by Bonus Distribution Ratio (BDR)


BDR (%) 150 51100 101200 201300 301400 401500 >500

All 93 100 86 37 29 11 15
% of Total 25.07 26.95 23.18 9.97 7.82 2.96 4.05
Average 175% Median 100%
Non-confounding (1,+2) 42 63 53 24 16 5 10
% of Total 19.72 29.58 24.88 11.27 7.51 2.35 4.70
Average 180% Median 120%
Non-confounding (5,+5) 31 43 43 19 10 4 7


% of Total 19.75 27.39 27.39 12.10 6.37 2.55 4.46


C
2011 Blackwell Publishing Ltd

Average 182% Median 125%


Notes:
This table shows the annual distribution of number of bonus distributions (Panel A) and the range of bonus distribution ratio (Panel B). All is for all the 371
announcements. Non-confounding (1,+2) and Non-confounding (5,+5) exclude any other news announcements over the 1 to +2 and 5 to +5 days relative to the
announcement date of bonus distribution. The respective sample sizes are 213 and 157.
WHY DO COMPANIES PAY STOCK DIVIDENDS? 615

Table 2
Market Reaction to All Bonus Distribution Announcements
Period Days ARt %>0 t-value Generalized Sign Test

Pre-event 5 0.0002 46% 0.14 0.24


4 0.0020 50% 1.15 1.21
3 0.0019 47% 1.09 0.28
2 0.0047 52% 2.66 2.05
1 0.0021 48% 1.19 0.49
Event 0 0.0149 57% 8.44 4.13
1 0.0094 51% 5.33 1.84

Post-event 2 0.0016 45% 0.88 0.66


3 0.0006 44% 0.32 1.08
4 0.0002 43% 0.11 1.49
5 0.0014 44% 0.81 0.76
Notes:
This table shows the daily mean abnormal returns around the event date 0 from day 5 to +5. The sample
includes 371 announcements of bonus distributions in the Istanbul Stock Exchange over the period 1995 to
2006. , , significant at 0.01, 0.05 and 0.10, respectively.

2. Similarly, for the sample of 157 announcements with no news over 5 to +5, the
only excess return over the pre- and post-event period is 0.73% (t = 2.32) on day 3.
For both samples, the respective excess returns are 1.58% (t = 6.50) and 1.79% (t =
5.69) on day 0; and on day +1, 0.76% (t = 3.11) and 1.0% (t = 3.17). These results,
not reported for space considerations, provide support to our hypotheses, and suggest
that the market reacts favourably to bonus distribution announcements in the ISE.
Table 3 reports the cumulative abnormal returns over various event windows. Using
the whole sample, it is interesting to note that in Panel A, share prices increase
abnormally by 1.10% (t = 2.79) over the pre-event period, and then by 2.44% (t =
9.74) on the event date (0 to +1), and then decrease by 0.26% (t = 0.74) over
the post-event period. Although the post-event cumulative return is not statistically
significant in terms of t-value, it is significant when the generalized sign test is used.
Panels B and C report the results based on restricted samples with no confounding
event over the (1 to +2) and (5 to +5) days relative to the announcement
date 0. The results are relatively similar and indicate that in the event period (0,
+1), share prices increase abnormally by 2.34% and 2.79%, respectively. However,
the pre- and post-event abnormal returns are not significant, suggesting that the
abnormal performance in Panel A is likely to be driven by other confounding news
announcements.
We also analyze the distribution of the event date abnormal returns across specific
sources of capitalization (i.e., the transfer of equity reserves to paid-in capital) and
find that the market reaction is positive and statistically significant regardless of the
specific sources; namely inflation equity reserves, other equity reserves and capital gain
reserves. In terms of total Turkish Lira value, the respective proportions of these three
sources are 80.9%, 5.1% and 14%, suggesting that the inflation revaluation reserves
are the main sources of capitalization. We do not report these results since we could
not detect any statistically significant difference in the market reaction of these three
categories of capitalization indicating that Turkish investors are not concerned with


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616 ADAOGLU AND LASFER

Table 3
Cumulative Abnormal Returns in the Pre-Event, Event, and Post-Event Periods
CAR %>0 t-value Generalized Sign Test

Panel A: All Announcements (N = 371)


CAR5,1 0.0110 51 2.79 1.73
CAR0,+1 0.0244 61 9.74 5.48
CAR+2,+5 0.0026 41 0.74 2.22

Panel B: Excluding Confounding Events Over (1,+2) Period (N = 213)


CAR5,1 0.0070 50 1.28 1.09
CAR0,+1 0.0234 62 6.79 4.40
CAR+2,+5 0.0044 42 0.91 1.37

Panel C: Excluding Confounding Events Over (5,+5) Period (N = 157)


CAR5,1 0.0072 50 1.02 1.15
CAR0,+1 0.0279 64 6.26 4.52
CAR+2,+5 0.0048 43 0.76 0.92
Notes:
This table shows the cumulative abnormal returns (CAR) for the pre-event (1 to 5), the event (0
to +1), and the post-event (+2 to +5) periods. Panel A shows the results for the whole sample of 371
announcements. Panels B and C report the CARs excluding any confounding events over the (1,+2)
and (5,+5) periods, respectively. The respective samples are 213 and 157 announcements of bonus
distributions in the Istanbul Stock Exchange over the period 1995 to 2006. , , significant at 0.01,
0.05 and 0.10, respectively.

the specific source for bonus distributions. Instead, the focus is on whether firms have
bonus distributions.

(iii) Bonus Distributions and Cash Dividend Payments


We assess whether firms fundamental characteristics drive bonus distributions. We
do this by comparing dividend-paying against non-dividend-paying firms. Previous
studies show that the market reaction to stock distributions depends on the firms
cash dividend payment. For example, Nayak and Prabhala (2001) find that the
average abnormal return on the announcement of stock splits is 1.84% for dividend-
paying compared to 2.98% for non-dividend-paying firms. Similarly, Grinblatt et
al. (1984) find significantly larger excess returns for non-dividend-paying firms. In
particular, they find an average two-day announcement return of 4.32% (6.46% for
stock dividends; 3.44% for stock splits) for non-dividend-paying firms, compared to
2.90% (3.56% for stock dividends; 2.75% for stock splits) for dividend-paying firms.
We expand further these results by assessing whether this asymmetric market reaction
reflects the severity of the impact of inflation on the paid-in capital of non-dividend-
paying firms.
Table 4, Panel A shows that the average (median) excess returns for dividend-paying
firms of 1.18% (0.8%) are statistically higher than 4.40% (2.9%) for non-dividend
payers. Both are statistically significant and are statistically different from each other.
We then assess whether the higher market reaction to non-dividend-paying firms
reflects the higher need to increase the eroding paid-in capital and potential dividend
payments in the future. We do this by comparing the fundamental factors across the
two sub-samples.


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WHY DO COMPANIES PAY STOCK DIVIDENDS? 617

Table 4
Market Reaction and Selected Financial Ratios for Non-Dividend Payers and
Dividend Payers
Panel A: Market Reaction
CAR(0,+1) Generalized Sign.
Classification Mean Median t-value Test %>0

Non-Dividend Payers (0) 0.0440 0.029 6.51 3.83 68


Dividend Payers (0) 0.0118 0.008 1.96 2.41 60
Difference in means and medians 0.0322 0.021

Panel B: Selected Financial Ratios


Differences in
Non-Div. Payers Div. Payers Mean Median

Operating Margin (1) 0.14 (0.13) 0.20 (0.20) 6.13 7.30


Operating Margin (0) 0.12 (0.12) 0.19 (0.18) 7.08 6.22
Operating Margin (+1) 0.14 (0.10) 0.19 (0.18) 5.10 7.52
Market Value (0, $m) 56.20 (26.3) 202.20 (69.5) 146.00 43.20
Unadjusted Stock Price (0, TL) 11.32 (6.10) 16.72 (10.10) 5.40 4.00
Market to Book Ratio (1) 1.79 (1.51) 2.45 (1.97) 0.66 0.46
Market to Book Ratio (0) 1.64 (1.15) 2.86 (2.19) 1.22 1.04
Market to Book Ratio (+1) 2.00 (1.46) 2.43 (1.86) 0.43 0.39
Debt/Equity (1) 1.73 (1.04) 1.01 (0.76) 0.72 0.28
Debt/Equity (0) 1.70 (1.08) 1.31 (0.76) 0.39 0.32
Debt/Equity (+1) 1.60 (1.13) 1.36 (0.71) 0.24 0.42
Debt/Paid-in Capital (1) 7.85 (4.28) 6.45 (3.93) 1.40 0.35
Debt/Paid-in Capital (0) 3.52 (2.43) 3.49 (2.49) 0.03 0.06
Debt/Paid-in Capital (+1) 4.52 (2.68) 4.89 (3.74) 0.37 1.05
Paid-in Capital/Equity (1) 0.30 (0.26) 0.26 (0.23) 0.04 0.03
Paid-in Capital/Equity (0) 0.50 (0.51) 0.39 (0.37) 0.11 0.14
Paid-in Capital/Equity (+1) 0.55 (0.43) 0.35 (0.32) 0.19 0.11
Notes:
This table presents the market reaction and selected financial ratios for non-dividend payers and dividend
payers. In Panel A, the two day (0,+1) cumulative abnormal returns of uncontaminated announcements
sample (5,+5) are presented classified by the firms that paid dividends in the event year (0) and the firms
that did not pay. In Panel B, several financial ratios with sample means and medians are calculated for the
fiscal years ending before the event (1), the event year (0) and the year after the event (+1). Parametric
t-test for the mean and the non-parametric Mann-Whitney U-test (MW U-test) for the median are both used
to detect the statistical significance of changes in mean and median. In Panel B, the figures in parenthesis
show the median. , , significant at 0.01, 0.05 and 0.10, respectively.

The results reported in Table 4, Panel B are in line with previous evidence (e.g.,
Fama and French, 2001), as non-dividend-paying firms are smaller and less profitable.
In particular, our non-dividend-paying firms have, on average, lower operating profit
margins in all analyzed fiscal years, and they are about four times smaller than non-
dividend-paying firms ($56m vs. $202m). Our results also indicate that the unadjusted
stock price of dividend-paying firms is significantly higher than that of non-dividend-
paying firms. Our results are in line with previous evidence which suggests that
bigger firms have a higher targeted stock price level (Stoll and Whaley, 1983; and
McNichols and Dravid, 1990). However, in contrast to previous studies (e.g., Fama
and French, 2001), our results indicate that dividend-paying firms have higher growth


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618 ADAOGLU AND LASFER

opportunities, as measured by market-to-book ratio. They also have a lower leverage,


as measured by debt-to-equity and debt-to-paid-in-capital ratios, than non-dividend-
paying firms in the pre-event year (1), suggesting that dividend-paying firms are less
likely to finance their assets with debt. In the event year 0, the debt-to-paid-in-capital
ratio decreases significantly because of the transfer of equity reserves to paid-in capital.
However, the difference in debt-to-paid-in-capital ratio between dividend-paying and
non-paying firms is not statistically significant in years 0 and +1. In contrast, the paid-
in-capital-to-equity ratio increases for both types of firms and becomes statistically
higher for non-dividend-paying firms in both year 0 and +1. The lower profitability
and higher financial leverage for non-dividend-paying firms may push them to increase
the paid-in-capital-to-equity ratio higher than the dividend payer firms, thus providing
more security for creditors in order to have access to borrowing. These results support
the paid-in-capital hypothesis.

(iv) Impact of Bonus Distributions on Firms Liquidity


We assess further the impact of bonus distributions on the liquidity of the firm. We
use five proxy measures for liquidity; share turnover, adjusted trading volume, relative
trading volume, market depth ratio, and the number of positive volume-zero return
days. The results reported in Table 5 are relatively mixed, in line with previously
documented evidence. Overall, the changes in all five measures are positive, indicating
enhanced liquidity. However, some of the changes in the measures are not statistically
significant, and the results depend on the sample used. For example, for the full
sample, the change in share turnover is not significant. However, when we exclude
confounding events, the change becomes significant. In contrast, the change for the
number of positive volume-zero returns days is not significant for the uncontaminated
sample but significant for the full sample.
We also assess whether the impact of bonus distributions is more pronounced in
less liquid stocks. We do this by sorting our firms into liquidity groups and analyzing
the changes in liquidity in each group. Table 6 reports the results. The five measures
of liquidity provide strong evidence that the change in liquidity is much more
pronounced in less liquid firms (Group 1). For the remaining groups, the evidence
is mixed. Although four of the five liquidity measures (Adjusted Trading Volume,
Relative Trading Volume, Positive Volume-Zero Return Days, Share Turnover) show
a decline in liquidity for firms with the highest pre-announcement liquidity, the results
show that only the change in the number of positive volume-zero return days in Panel E
is statistically significant. Our results are consistent with Wulffs (2002) finding for the
German stock splits, where the less liquid shares have relatively larger improvement of
liquidity. However, in the US, the evidence is mixed, possibly due to the effect that the
level of pre-stock split liquidity is not considered (e.g., Copeland, 1979; Lakonishok
and Lev, 1987; Conroy et al., 1990; and Han, 1995).

(v) Regression Results


In this section, we assess the joint determinants of the bonus distribution ratio and
the market reaction to the bonus distribution announcements. Table 7 presents the
regression results of the determinants of bonus distribution ratio. In line with previous
evidence (e.g., McNichols and Dravid, 1990; and Nayak and Prabhala, 2001), our


C 2011 Blackwell Publishing Ltd
WHY DO COMPANIES PAY STOCK DIVIDENDS? 619

Table 5
Liquidity Analysis
Wilcoxon Signed
t-differences in Rank Test
Change () in Mean Median %>0 Means (p-value) (p-value)

Panel A: All Announcements (N = 371)


Share Turnover 0.0008 0.0002 53 1.49 34,152
(0.14) (0.16)
Adjusted Trading Volume 0.0285 0.0533 53 0.66 32,240
(0.51) (0.67)
Relative Trading Volume 0.3708 0.3328 62 6.44 43,243
(0.00) (0.00)
Market Depth 0.0759 0.0557 54 1.79 35,349
(0.08) (0.04)
Positive Volume-Zero Return Days 1.5790 1.5000 53 1.84 26,884
(0.07 ) (0.08)

Panel B: Excluding Confounding Events Over (5,+5) Period (N = 157)


Share Turnover 0.0014 0.0003 56 1.95 6,128
(0.05) (0.09)
Adjusted Trading Volume 0.0807 0.0932 57 1.28 5,828
(0.20) (0.23)
Relative Trading Volume 0.4170 0.3587 65 5.25 7,634
(0.00) (0.00)
Market Depth 0.1517 0.1826 60 2.51 6,681
(0.01) (0.01)
Positive Volume-Zero Return Days 0.4700 1.0000 49 0.45 4,672
(0.65) (0.59)
Notes:
This table shows changes in liquidity measures (in lots) between the pre-announcement (260 to 21)
and post delivery (+21 to +260) periods. Share turnover is the ratio of unadjusted trading volume over the
number of shares outstanding. Adjusted trading volume is the average daily trading volume adjusted for
bonus distribution. Relative trading volume is the ratio of the average unadjusted trading volume divided
by the average market volume for each period. Market depth ratio is  t (VOLi,t )/  t (|Ri,t |) where VOLi,t
and |Ri,t | are the adjusted trading volume and the absolute return respectively on stock i on day t during
the period before the announcement and after the delivery. Positive Volume-Zero return days count the
number of days of positive volume-zero return before and after. The last two columns report the t-statistics
of differences in means and the Wilcoxon Signed Rank test to test for differences in the medians. Panel A
is based on for the full 371 observations. Panel B shows the results for the uncontaminated announcements
sample (5,+5) and the sample size is 157. , , significant at 0.01, 0.05 and 0.10, respectively.

results indicate that the pre-bonus distribution market price is positive and significant,
implying that the higher the stock price, the higher the bonus distribution ratio, and
suggesting that managers choose their distribution ratio to bring the stock price to its
optimal level. In contrast, the bonus distribution ratio is negatively related to firms
size as measured by its market value of equity, in line with previous evidence (Stoll
and Whaley, 1983; and McNichols and Dravid, 1990), suggesting that larger firms are
reluctant to have large bonus issues to depress their stock price, as they prefer to
have a higher targeted stock price. The statistically significant positive coefficient of
debt-to-paid-in-capital ratio suggests that firms with high debt-to-paid-in-capital ratio
declare higher bonus distribution to bring down the ratio for more credibility and
borrowing capacity, as implied in hypothesis H1 . In line with our expectations, share
turnover, ST, is positive but statistically insignificant, and contrary to our expectations,


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620 ADAOGLU AND LASFER

Table 6
Liquidity Analysis by Liquidity Groups
t-differences Wilcoxon
Sorted Group Mean Median in Means Signed Rank
(Ascending in liquidity) Change Change %>0 (p-value) Test (p-value)

Panel A: Change in Share Turnover


1st 0.0020 0.0006 73 2.38 983
(0.02) (0.00)
2nd 0.0007 0.0006 48 1.00 574
(0.32) (0.89)
3rd 0.0015 0.0019 46 0.81 646
(0.42) (0.56)

Panel B: Change in Adjusted Trading Volume


1st 0.3260 0.2600 67 2.57 821
(0.01) (0.02)
2nd 0.0140 0.0505 54 0.14 583
(0.89) (0.96)
3rd 0.0702 0.0382 50 0.77 542
(0.44) (0.64)

Panel C: Change in Relative Trading Volume


1st 1.013 1.118 83 7.35 1,086
(0.00) (0.00)
2nd 0.282 0.300 67 2.59 854
(0.01) (0.01)
3rd 0.044 0.131 46 0.37 547
(0.71) (0.68)

Panel D: Change in Market Depth


1st 0.2950 0.2010 65 2.30 796
(0.03) (0.03)
2nd 0.0800 0.2110 58 0.72 747
(0.48) (0.10)
3rd 0.0797 0.0972 56 1.28 747
(0.21) (0.10)

Panel E: Change in Positive Volume-Zero Return Days


1st 8.69 11.25 25 4.55 192
(0.00) (0.00)
2nd 0.73 1.00 44 0.55 565
(0.58) (0.79)
3rd 6.54 5.50 69 4.67 899
(0.00) (0.00)
Notes:
This table extends the liquidity analysis of Table 5 and shows five different measures of the change in the
liquidity sorted (in ascending order) by the average of the liquidity measure during the pre-announcement
period of (260,21). The tables present the change in each liquidity measure for each sorted group
accompanied by difference tests for the mean and median. The sample includes 157 announcements of
bonus distributions in the Istanbul Stock Exchange over the period 1995 to 2006 without any confounding
news over the (5,+5) period. , , significant at 0.01, 0.05 and 0.10, respectively.


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Table 7
Determinants of the Bonus Distribution Ratio

WHY DO COMPANIES PAY STOCK DIVIDENDS?


0 P MV DPC ST RUNUP Adj. R 2 F-stat.

(1) 3.192 0.686 0.196 0.073 9.483 0.443 38.53% 18.93


(2.27) (4.01) (2.33) (3.22) (1.40) (1.45)
(2) 0.4947 0.627
(1.83) (4.44) 14.26% 26.78
(3) 4.422 0.147
(2.59) (1.52) 0.9% 2.33
(4) 1.013 0.114 29.65% 66.32
(7.61) (5.17)
(5) 1.013 3.077 0.0% 0.10
(12.22) (0.30)
(6) 1.787 0.427 0.7% 2.23
(12.89) (1.49)
Notes:
The table shows the regression results of the determinants of the bonus distribution ratio for the 157 uncontaminated announcements of bonus distributions in the
Istanbul Stock Exchange in 1995 to 2006 over (5,+5) period. The dependent variable is BDR, the bonus distribution ratio. P is the natural log of unadjusted stock
price at the end of quarter before the bonus distribution announcement. MV is the market value of the firm at the end of quarter before the bonus distribution
announcement. DPC is the debt-to-paid-in-capital ratio at the end of fiscal year before the bonus distribution announcement. ST is the average daily share turnover
for the period (260,21) before the announcement. RUNUP is the cumulative abnormal return for the period (140,21) before the announcement. The White
heteroskedasticity-consistent t-statistics are in between parentheses. , , significant at 0.01, 0.05 and 0.10, respectively.

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622 ADAOGLU AND LASFER

the coefficient of the cumulative abnormal return for the period (140, 21) before
the announcement, RUNUP,21 is negative and statistically insignificant. These results
suggest that firms with an unusual price increase before the bonus distribution
announcement may depress the need to have a higher bonus distribution ratio. Our
result of statistically insignificant ST is not in line with Nayak and Prabhalas (2001)
finding that share turnover is positive and statistically significant, suggesting that firms
with higher share turnover are more likely to announce stock splits.
We also provide the results with a single variable at a time to check for any
multicollinearity effect. The results reported in the remaining rows of Table 7 (Row
(2) through Row (6)) are relatively consistent with the first row, and indicate that
the main drivers of the bonus distribution ratio are the price and the debt-to-paid-in-
capital ratio. Although size is negative, it is not significant, suggesting that it is not size
per se that drives companies to have lower bonuses, but its combination with debt-to-
paid-in-capital ratio and the price level.
Table 8 reports the regression results for the determinants of the magnitude of
event period market reaction, CAR(0,+1) . The results indicate that companies with high
debt-to-paid-in-capital ratio, DPC, generate higher event period abnormal returns in
all specifications. Similarly, the cumulative abnormal returns are positively related to
the bonus distribution ratio, BDR. The market price, P, is not significant and its sign
changes, suggesting that, in contrast to Rankine and Stice (1997), firms with a high
level of stock price are not anticipated by the market to declare a bonus distribution,
and, as a result, do not generate lower market reaction. These results also indicate
that the market does not necessarily expect firms with a higher level of stock price
to have bonus distributions to bring down the price level to an optimal range. The
coefficient of the cumulative abnormal return for the period (140, 21) before
the announcement, RUNUP, is negative and statistically significant, suggesting that
the bonus distribution signals that the firm is undervalued and further good news is
expected in the future. However, the results indicate that size, as measured by the
market value of equity, MV, is not statistically significant, suggesting that the market
reacts in the same way to small as well as large firms, and ISE firms are less likely to
have bonus distributions to attract the attention of financial analysts. Our results are,
therefore, not consistent with the attention-getting hypothesis.
The coefficient of share turnover, ST, is statistically insignificant and its sign changes
dependent on our specifications, in line with previous studies that report a mixed
evidence for the liquidity effect. However, the coefficient of the dummy variable
for firms in the lowest share turnover group, STLOW, is positive and significant,
suggesting that the impact of liquidity is much more pronounced for the low liquidity
firms, as reported in Table 6.
Finally, the first two rows of Table 8 show that the market reaction is significantly
higher for bonus distributions that occurred in 2005 and 2006, and for those
distributed by non-dividend-paying firms, as reflected in the positive coefficients of the
two dummy variables INF and NP. These results suggest that the signaling role of bonus
distribution is higher when the inflation impact is low, i.e., when bonus distributions
are more difficult for ISE firms, and when the firms do not use cash dividend payments
to signal their future prospects. Although these later results may capture the strong

21 Instead of using the cumulative abnormal return for the RUNUP variable, we also used the daily
compounded rate of return during the pre-announcement period as suggested by Rankine and Stice (1997)
and Nayak and Prabhala (2001), but the results do not change.


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Table 8
Determinants of the Market Reaction to Bonus Distribution Announcements
0 DPC BDR P MV ST RUNUP PDIV SDIV INF STLOW NP N Adj. R 2 F-stat.

WHY DO COMPANIES PAY STOCK DIVIDENDS?


(1) 0.011 0.003 0.002 0.007 0.198 0.025 0.045 0.029 0.026 157 14.99% 4.15
(1.24) (3.53) (0.21) (1.39) (0.40) (1.91) (1.70) (2.07) (2.07)
(2) 0.040 0.025 0.045 0.024 0.030 157 34.71% 20.01
(4.00) (8.07) (2.04) (2.19) (2.95)
(3) 0.091 0.003 0.013 0.005 1.093 0.024 0.004 0.022 0.032 69 7.49% 1.82
(0.84) (2.82) (1.35) (0.87) (0.80) (1.12) (0.89) (0.69) (1.60)
(4) 0.127 0.003 0.014 0.007 1.221 0.022 0.005 0.029 0.025 69 18.07% 2.76
(1.24) (3.16) (1.54) (1.30) (0.95) (1.18) (2.85) (0.99) (1.46)
(5) 0.024 0.015 0.002 0.031 0.021 69 20.42% 5.11
(1.98) (4.04) (0.65) (1.10) (1.57)
(6) 0.020 0.014 0.003 0.038 0.016 69 25.58% 6.50
(1.94) (3.88) (2.15) (1.44) (1.23)

Notes:
This table shows the regression results of the determinants of the market reaction CAR(0,+1) to bonus distributions in the Istanbul Stock Exchange over the period
1995 to 2006. The sample in Row (1) and Row (2) includes the 157 uncontaminated announcements over the period 5 to +5 relative to bonus distribution
announcements. When we consider only cash dividend payers in Row (3) through Row (6), our sample includes 69 announcements. DPC is debt-to-paid-in-capital
ratio. BDR is the bonus distribution ratio. P is the natural log of unadjusted stock price at the end of quarter before the bonus distribution announcement. MV is
the natural log of market value of equity in US$ at the end of quarter before the bonus distribution announcement. ST is the average daily share turnover for the
period (260, 21) before the announcement. RUNUP is the cumulative abnormal return for the period (140, 21) before the announcement. PDIV [SDIV] is
the adjusted change in the cash dividend that is paid in [subsequent to] the event year. INF is a dummy variable equal to 1 for firms with bonus distributions in
2005 and/or 2006. STLOW is a dummy variable equal to 1, if the firm is in the lowest share turnover group. NP is a dummy variable equal to 1 if the firm does not
distribute cash dividends in the event year. N is for the number of observations. The White heteroskedasticity-consistent t-statistics are in between parentheses. ,
, significant at 0.01, 0.05 and 0.10, respectively.

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624 ADAOGLU AND LASFER

differences between dividend-paying and non-dividend-paying firms documented in


Table 4, they suggest that the market welcomes the return generated through the
additional share capital distribution.
In the remaining results (Row (3) through Row (6)), we test further the retained
earnings/signaling hypothesis under the ISE settings, as we include PDIV and SDIV,
the adjusted change in the cash dividend that is paid in and subsequent to the event
year, respectively. The sample size decreases to 69 announcements as it is limited to
only companies with cash dividends in both the pre-announcement and the event
year. The results indicate that CARs are not affected by the change in dividends from
previous level, PDIV, since although its coefficient is positive, it is not significant. This
is probably due to the fact that more than 85% of the actual delivery of bonus shares
takes place after the distribution of cash dividends to the old shares, and the new bonus
distribution shares are only entitled to the new cash dividends in the coming year.
However, CARs are positively and statistically related to subsequent dividend changes,
SDIV. The results indicate that firms informally signal a possible subsequent dividend
change at the time of bonus distribution announcement, supporting the retained
earnings/signaling hypothesis.

5. CONCLUSIONS
We show that the market reacts positively to the announcement of bonus distributions
in the Istanbul Stock Exchange. We contribute to the literature by proposing another
hypothesis for explaining the positive market reaction, referred to as the paid-in
capital hypothesis. The Turkish settings provide a unique feature to develop the paid-
in-capital hypothesis and to explore further the previously documented motivations
for free share distributions. The paid-in-capital hypothesis stipulates that bonus
distributions allow firms to mitigate the impact of inflation on their eroding paid-
in capital, to reduce their leverage measured by debt-to-paid-in-capital ratio, and to
increase their credibility and borrowing capacity, in a market of limited access to
external equity financing. We argue that companies are more likely to have bonus
distributions to increase the amount of paid-in capital, as the high levels of inflation
adversely affect the real value of paid-in capital, and reduce their credibility. In a
market of heavy reliance on short-term borrowing, the amount of paid-in capital
becomes more important in order to have access to debt financing for growth and/or
survival. We, therefore, relate the annual frequency of bonus distributions to the trend
in the inflation rates and find strong positive correlations.
We also test the previously documented hypotheses, including the retained earn-
ings/signaling, liquidity enhancement, and the attention-getting. We find relatively
weak support for these alternative hypotheses. We provide some rational explanations
for the controversial debate as to why the market reacts more positively to non-
dividend-paying firms in cases of stock distributions, as we find that these firms
are likely to be weak financially, and the motivations for bonus distributions (i.e.,
improvement in the paid-in-capital, decrease in the debt-to-paid-in-capital ratio, and
increase in debt capacity) focus on allowing these particular firms to regain their
financial health.
The market reaction is also positively related to the subsequent changes in adjusted
dividends providing support for the retained earnings/signaling hypothesis in a
different context. At the same time, the lower market reaction and the prevalence


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WHY DO COMPANIES PAY STOCK DIVIDENDS? 625

of the subsequent change in dividends in explaining the market reaction for dividend
payers also support the informational substitute hypothesis. However, the empirical
analysis of the two not mutually exclusive hypotheses, namely the informational
substitute hypothesis and the differential expectations hypothesis, and their precise
level of contribution to the positive difference are beyond the scope of this paper.
There are three well-defined forms of stock distributions in the ISE, namely bonus
distributions, stock dividends and stock splits. We could not find any company with
stock splits, even though such distributions are legal in Turkey. Instead, we report that
Turkish firms typically issue stocks at the minimum legally possible nominal price,
making it impossible to reduce the par value through stock splits.22 The nonexistence
of stock splits provides an opportunity to test the previously documented liquidity
hypothesis mainly in the case of stock splits. Therefore, if companies in Turkey do
not have stock splits, do they use bonus distributions to increase their liquidity?
In line with previous studies, we find mixed evidence for the liquidity effect,
except for the lowest liquidity firms where we find significant improvements in their
liquidity. Firms whose shares are already liquid do not have any statistically significant
positive changes and in some measures, they have a negative change in liquidity. In a
multivariate regression framework, share turnover is not always significant. However,
after controlling for other related factors, we find evidence that stocks with the lowest
liquidity have a higher level of market reaction. Specifically, for dividend payers, which
are larger, and have a higher level of targeted share price, the subsequent change in
the dividends is a prevalent determinant in explaining the market reaction. However,
dividend-paying firms with high share turnover during the pre-announcement period
and/or those in the lowest liquidity group do not generate different market reaction
than other firms. We also do not detect any empirical support for the attention-
getting hypothesis, and this finding is consistent with the high frequency of bonus
distributions in the ISE. Overall, our results contribute to the existing literature,
but since our sample covers a period of high and low inflation and it is limited
to the Turkish market, the extent to which these results apply to other developing
and developed countries and to other sample periods, is the subject of further
research.

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