How dividends affect stockholder equity?

When a company pays dividends to its shareholders, its stockholders' equity is decreased by the total value of all dividends paid.

What Are Dividends?

When a company is doing well and wants to reward its shareholders for their investment, it issues a dividend. Dividends also offer a good way for companies to communicate their financial stability and profitability to the corporate sphere in general. Stocks that issue dividends tend to be fairly popular among investors, so many companies pride themselves on issuing consistent and increasing dividends year after year. In addition to rewarding existing shareholders, the issuing of dividends encourages new investors to purchase stock in a company that is thriving.

What Is Stockholder Equity?

Stockholder equity represents the capital portion of a company's balance sheet. The stockholders' equity can be calculated from the balance sheet by subtracting a company's liabilities from its total assets. Although stock splits and stock dividends affect the way shares are allocated and the company share price, stock dividends do not affect stockholder equity.

Stockholder equity also represents the value of a company that could be distributed to shareholders in the event of bankruptcy. If the business closes shop, liquidates all its assets and pays off all its debts, stockholder equity is what remains. It can most easily be thought of as a company's total assets minus its total liabilities.

One of the chief components of stockholder equity is the amount of money a company raises through the sale of shares of stock, called equity capital. However, even private companies, which are not publicly traded, have stockholder equity.

Though uncommon, it is possible for a company to have a negative stockholder equity value if its liabilities outweigh its assets. Because stockholder equity reflects the difference between assets and liabilities, analysts and investors scrutinize companies' balance sheets to assess their financial health.

The Effect of Dividends

The effect of dividends on stockholders' equity is dictated by the type of dividend issued. When a company issues a dividend to its shareholders, the value of that dividend is deducted from its retained earnings. Even if the dividend is issued as additional shares of stock, the value of that stock is deducted. However, a cash dividend results in a straight reduction of retained earnings, while a stock dividend results in a transfer of funds from retained earnings to paid-in capital. While a cash dividend reduces stockholders' equity, a stock dividend simply rearranges the allocation of equity funds.

Source : Investopedia