Before we answer the question, let us understand the dividend distribution process.
DIVIDEND DISTRIBUTION PROCESS
There are three important periods /dates in the dividend distribution process 1. Cum Dividend Period, 2. Ex-Dividend Period and, 3. Pay Date. Let us see what these dates mean.
1. Cum Dividend Period
Cum dividend means 'with dividend' and this is the period from the declaration of dividend and before the ex-dividend period.
The significance of this period is that if someone buys a share in this period, she will be eligible to get the dividend and the seller will lose the right to receive the dividend.
2. Ex-Dividend Period
In this period the company has already confirmed the list of shareholders who will receive the dividend.
The significance of this period is that if someone buys a share in this period, she will NOT receive a dividend but the seller will.
3. Pay Date
This is the date on which actual payment of dividend happens.
WHY SHARE PRICES GO DOWN AFTER DIVIDEND IS DECLARED?
Imagine that a company who declared dividend has Rs. 100 book value per share out of which Rs. 40 is in cash reserve and rest in other assets net the liabilities. The shares of the company have a face value of Rs. 10 per share and company has declared a 100% dividend i.e. Rs. 10 dividend per share.
Now, during the cum dividend period, a person who buys the share for the company also receives the right on the dividend. But, in the ex-dividend period (after the list of dividend receivers already fixed) the buyer does not get the right to the dividend.
There is another thing happening here. The dividend of Rs. 10 will be paid from the cash reserve of Rs. 40 per share. That means after the company pays the dividend the cash reserve per share will dicrease by the dividend amount.
If a transaction happens after the cum-dividend period (i.e. during the ex-dividend period) the buyer of a share will not receive the dividend declared but the book value of the share decreases by the dividend value, the price of shares theoretically should decrease by the dividend amount. This is why we often see a price drop after a dividend is declared.
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