Talk:share dilution
This text has been removed from the article as encyclopedic. I stored it here for the time being to check whether some of it should be included in the Wikipedia article on stock dilution (which is the same thing as share dilution) Hekaheka 20:05, 25 October 2007 (UTC)
The greatest share dilution results from a company giving away stock rather than selling it on the open market. This giveaway is called a stock grant. It sounds unreasonable, but corporations do it regularly. Boards of Directors award stock grants to top executives. The amount of the dilution from a stock grant can be calculated precisely. The company's total value remains the same after the grant as before, but it must be spread over a greater number of shares (those outstanding before the issuance of new shares, plus the new shares). Therefore the value of each share declines arithmetically. Total dilution ends up equaling the amount of money the grantee can get for his shares. If the corporation were a two-person family with $1,000 in their safe, each family member (stockholder) would own one share worth $500. If a judge awarded a third person equal ownership of the safe's contents (granted him one share), the original two shares' values would be diluted. To calculate the amount, divide market capitalization (2 shares times $500 each equals $1,000) by total shares outstanding after the grant (3) equals $333.33. This is the value of one share after the grant. Dilution per share is $500 minus $333.33 or $166.67. Total dilution is 2 original shares times $166.67 dilution per share or $$333.33. More directly, dilution equals new shares granted divided by shares outstanding after grant, times company value (1/3 x $1,000). A corporation's granting of shares to an executive removes money from the other shareholders pockets just as surely as the judge's award reduces the amount of money each of the original family members owns in the safe.
Stock options also result in share dilution, but to a lesser degree than grants because the option holder has to pay something for the shares. That "something" the option holder must pay is called the strike price, the discounted price at which the holder is allowed to buy the shares. When exercised in a typical "cashless" manner, the holder of the option borrows the money from the brokerage firm to buy shares at the strike price then immediately sells them at market price. He repays the loan, pays the broker a commission on the two trades and pockets the difference. The company could have received full market value for the shares had it sold them on the open market so the difference between the strike price and market value times the number of shares exercised equals total dilution, the amount of money removed from (or not added to) the corporate treasury. Taking money from the corporate treasury is the same as taking it from the stockholders because the stockholders own the company.
Why does share dilution from stock grants and options occur so frequently? Stock grants and options are awarded to a company's executives by its Board of Directors which is required by law to act in the best interests of the stockholders. Unfortunately, in the United States the decisions of a Board of Directors are usually influenced by the sometimes self-serving wishes of management. Indeed in almost all American companies' not only is the company's top executive on the Board of Directors, but he is also its Chairman. Other company executives often occupy other seats on the board. Still other seats may be occupied by the president of the legal firm the company hires, and the firm that handles the company's advertising. These firms stand to lose business if management becomes displeased with the voting of those directors. Another thing that helps management influence the decisions of the Board of Directors is the fact that stockholders often vote their proxies "as management recommends" to avoid reading the often-100-page Proxy Statement. Management always recommends the approval of grants and options for themselves. For all of these reasons, the chairman of the SEC and many other people feel that American executives now award themselves free and discounted shares of stock at will. The result is the regular dilution of stockholders' share values.
Share dilution may also result from events other than the issuance of stock grants and options. The sale of a division of the company for less than its market price results in share dilution (lower company value divided by the same number of shares). So would a corporate contribution to a charity if the resulting goodwill was worth less than the contribution. Dilution al so results from purchasing another company, whether for cash or stock, if the purchase price is greater than market value. This is virtually always the case.