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Many firms with dividend reinvestment plans also allow their shareholders to voluntarily invest supplemental funds to purchase additional shares. The purchase price for newly-issued shares often is determined by the average stock price over a prespecified time period preceding the investment date. This gives the firm's shareholders an option to invest in additional shares only when the stock price exceeds the computed average. This paper uses both theoretical and numerical methods to analyze the value of these voluntary purchase options in theory and practice. MOST FIRMS WITH DIVIDEND reinvestment plans also allow their shareholders to voluntarily invest additional funds through organized open market purchases of outstanding shares or the direct issuance of new shares, thereby facilitating investment in the firm by small shareholders and, in the latter case, providing an alternative mechanism for the firm to issue securities. Typically, shares acquired in the open market are sold to shareholders at the average price paid by the firm to acquire the shares, while newly issued shares are sold to shareholders at a price determined by a formula specified in the plan's prospectus. For example, in most instances the purchase price for newly issued shares is the average of daily closing (or daily high and low) stock prices over some prespecified period of time, such as the last five trading days of the month. These designs sometimes create valuable options. If the purchase price for shares is computed as an average of prices taken over a period of time that precedes (or partially precedes) the last date on which the firm will accept voluntary cash investments, the investor can use the available price information to decide whether to invest funds. The purpose of this paper is to analyze the value of these voluntary purchase options (VPOs) in theory and practice. |
