Korea Capital Market Institute

Korea’s capital markets have grown substantially in size and numerous innovations and developments have materialized. However, the markets still fall behind in developing and using alternative corporate financing tools, other than conventional stocks and bonds. Under the circumstances, a Dividend Reinvestment Plan(DRIP), a slightly mutated equity investment scheme, can be valuable to companies, and offer great opportunities to investors. The Basic Concept and Structure of DRIPs DRIP participating shareholders can reinvest their dividends in the equity of the underlying company. In some cases, shareholders are given Optional Cash Purchases(OCP) through which they can purchase additional shares with cash. In some DRIP formats, not only existing shareholders, but new investors also are allowed to purchase the underlying equity. Therefore, the DRIP concept is not limited to dividend reinvestments. It can be understood as a way of direct equity transactions between shareholders and the underlying company. DRIP Benefits The biggest benefit from DRIPs is that they allow small investors to minimize their initial investment principal and transaction costs incurred by direct investments. In addition, they offer attractive investment opportunities through various discount and investment options. From a corporate financing perspective, DRIPs can be viewed as a form of equity issuance. Besides, a company can reap benefits from DRIPs: It can stabilize its managerial control, efficiently raise capital, and boost sales by securing loyal customers. History of DRIPs DRIPs originate back to the 1920s and 30s when mutual funds adopted a certain method to reinvest dividends. In 1957, Lehman Corporation became the first listed company to provide a DRIP. Since then, many investment service firms have developed their own version of DRIPs. In 1968, the Securities and Exchange Commission (SEC) revised its regulations to allow general non-financial firms to offer DRIPs. In December 1994, the SEC modified DRIP regulations again; under the new regulations, the DRIP implementation procedures were significantly streamlined. According to recent research(Larkin, Lee &Wane, 2005), in the U.S., over 1,800 companies including most Fortune 500 firms offer DRIPs, and around 5million investors enroll in DRIPs. Problems in DRIP Investments in Korea DRIPs are widely accepted as an equity investment tool and frequently used by general investors in the U.S. and Canada. However, in Korea, most investors are unfamiliar with the concept of DRIPs. This presumably stems from Korea’s strict laws governing corporate dividend policy and all transactions related to its own stocks, including new stock issuance. Also, Korea’s equity investment culture where dividend investments and long-term investments are less popular seem to affect the trend. In this paper, we suggest the following in order to successfully and efficiently introduce and promote DRIPs in Korea. 1. Ensure that DRIPs do not violate shareholder equality First, DRIPs can violate the shareholder equality principle, which is a prerequisite for provisions concerning shareholder rights stipulated in the Commercial Code of Korea. DRIPs have an ex-ante problem because they exclude the enrollment of major shareholders, and an ex-post problem because they can cause discrimination between participating and non-participating minority shareholders. However, such discrimination is not considered serious in economic terms. Furthermore, Korea currently has a unique differential dividend scheme, where minor shareholders receive higher dividends or major shareholders receive no dividends at all as long as the major shareholders consent. Therefore, the shareholder equality problem can be resolved through an appropriate scheme. Specifically, what is necessary is a convenient and stable scheme which neither requires the consent of major shareholders every time nor incurs high transaction costs. A recommendation here is to revise the articles of incorporation or the memorandum of understanding with major shareholders to include DRIP-related provisions. 2. A more flexible dividend policy is required According to the Commercial Code of Korea, stock dividends are allowed only for new shares distributed at the end of the fiscal year on an annual basis. Therefore, in order to promote the use of stock dividend reinvestment, laws and regulations should be revised to permit quarterly stock dividends. Also, treasury stocks should be allowed to be used as dividends, as long as they are distributed as part of a DRIP. 3. A more realistic approach for payment methods used for DRIPs Another important issue in a DRIP is the kinds of stocks offered to the DRIP enrollees. In the U.S., new and old shares are allowed for the DRIP. Although Korea closely regulates new share issuance and treasury stock transactions, it does not completely ban DRIPs. However, exceptions or other clear instructions related to issuing new stocks, or trading and disposing treasury stocks for DRIPs should be considered. 4. Consider how to implement a DRIP. Stock purchases for a DRIP can lead to an unexpected increase in trading volume and stock prices. Therefore, appropriate measures, e.g., buying stocks over a time period(accumulation), or holding a certain amount of treasury stocks, should be put in place to curb market volatility. In addition, offering benefits to DRIP enrollees will help promote the use of DRIPs in Korea. A company could offer discount or additional purchase options, and the government could consider giving temporary tax benefits to DRIP participants.