An empirical examination of the effect of the accounting for stock distributions

This study provides evidence of whether separating contributed from earned capital in the stockholders' equity section of the balance sheet is still relevant. The evidence comes from examining the transfer from retained earnings to contributed capital because of a stock dividend. If this transfer from retained earnings to contributed capital is perceived to be costly, then it matters whether an amount is in retained earnings or in contributed capital.;This study shows the results of three separate tests: the stock market's reaction to the announcement of a small stock dividend, the stock market's reaction to the announcement of a large stock dividend, and the firm's choice of the accounting for a large stock distribution. The results of both the stock market's reaction to a small stock dividend announcement and the firm's choice of the accounting for a large stock distribution show that the transfer from retained earnings is perceived to be costly.;In addition to providing evidence of whether the transfer from retained earnings because of a stock dividend is perceived to be costly, this study also examines whether the perception by the stock market and the firms to that cost is better explained by contracting theory or signaling theory. The results show that the stock market's reaction to a small stock dividend announcement is consistent with signaling theory while the firm's choice of distribution structure for a large stock distribution is consistent with contracting theory.;The results of this study have implications both for the accounting rules concerning stock distributions and for the information displayed in the stockholders' section of the balance sheet. In terms of the accounting rules for stock distributions, the FASB should maintain the accounting rules for small stock dividends because they help firms to signal relevant information to financial statement users. In terms of the stockholders' section of the balance sheet, financial statement users care whether an amount is in contributed capital or earned capital and, thus, breaking out this detail in the stockholders' section should continue.