Companies originally established dividend reinvestment plans, or DRIPs, to enable their employees to invest in the company through stock purchase plans. These companies soon realized that they could expand the program to investors, and because the plans were already in place, they could cost-effectively handle the expansion.
Companies knew that if investors reinvested their dividends, the companies could sell new shares and raise new capital without having to go through the lengthy and expensive regulatory process of a full-blown secondary stock offering. They could sell shares directly to investors for less cost than having to hire an investment bank to underwrite the new shares.
Companies with large capital needs, such as utilities, financials, and real estate companies, realized this strategy was so advantageous to them that they encouraged investors to reinvest their dividends by offering discounts of as much as 5 percent off the share price.
The only rule was that participants were required to own at least one share of the company's stock to participate in the program. This rule is still in place for many DRIPs today to restrict participation to employees and investors who are serious about making a long-term commitment to the company. Some DRIPs may waive this rule and let investors buy shares through a direct enrollment plan.