A dividend reinvestment plan (DRP) allows investors to use their dividends to buy additional shares in the issuing entity. Instead of issuing a dividend, the corporation uses the cash to buy more shares on behalf of an investor. Corporations offer a DRP so that they can retain dividend payments that would otherwise be paid to investors. Common enticements are the avoidance of a sales commission on the purchase of these additional shares, as well as a modest discount from the market price. These plans also tend to encourage longer-term investing by investors, which contributes to reduced investor turnover.
The main downside to the DRP concept is that investors must still pay income taxes on their dividends, even though the related cash is not available for paying the taxes (having been reinvested). In addition, the investor must keep track of the cost basis of each block of shares acquired under a DRP, which is later used to calculate taxable income when the shares are eventually sold. This can be burdensome when share purchases are being made on behalf of an investor four times a year (to correspond with the usual quarterly dividend payments).