A corporation's earnings are usually retained instead of being distributed to the stockholders in the form of dividends because the corporation is in need of money to strengthen its financial position, to expand its operations, or to keep up with the inflation in its present size of operations.

The stockholders may prefer to forego dividends in order to see its stock value increase from the corporation's wise use of the retained earnings. This is especially true of  U.S. individuals in high federal and state  income tax brackets. These stockholders might end up paying 40% of the dividend amount in income taxes. They would rather have their stock appreciate in value with no tax payments and later sell their shares of stock at the lower capital gains tax rates.

Learn Accounting: Gain unlimited access to our seminar videos, flashcards, visual tutorials, exams, business forms, and more when you upgrade to PRO.