Payment-In-Kind - PIK

So you know what a normal, vanilla dividend is right? A company is so profitable, it can’t think of anything else to do with its excess cash. So it just gives it back to its shareholders. Really nice gig if you can get it.

A company’s stock trading at 20 bucks a share pays 20 cents a quarter in dividends, or 80 cents a year, and yields 4%. That’s 80 cents over 20 bucks. Simple vanilla dividend.

Companies also often carry debt. The company whatever.com has $50M in debt, which costs them 6% a year, or $3M a year to pay the interest rent on that money. When times are good, the company pays the interest in cash, but dividends and interest payments aren’t necessarily always paid in cash.

They can be paid in stock as well. And yes, this is weird. Why would a company pay a dividend or bond interest in its own stock?

That would dilute the equity ownership of the company. So, why would they do it? Because they had to. Some companies will have offered bonds, which give the company the option of paying the interest either in stocks or in cash and if the company thinks it is in jeopardy of potentially going bankrupt, it will pay its interest obligations in stock instead, and this is generally a very bad thing.

Or at least something that communicates to its equity holders that either the company’s stock is overvalued, so it is choosing to dilute equity holders by using it as a currency or it is communicating that the company’s cash obligations are so high it’s fearful of the “B” word.

Companies will also pay dividends in stock at times for largely the same reasons, but with different dilution dynamics because in the case of the equity owners of the company, all receiving pro rata, or equally the same number of incremental shares as dividends means that the company is, yes, diluting itself, but doing so equally to basically everyone who is a common shareholder.

So who does this screw?

Option holders. Employees. If they only own options, they are not entitled to dividends, whether in cash or stock, and they get diluted away for their hard efforts. This is called PIK, or Payment in Kind. Although, to those screwed-over option holders, there’s uh…not much “kind” about it...