As the owners of the organization, shareholders are motivated by increased returns. Therefore, corporate leadership has to consider the implications of certain decisions on the existing shareholders. When an organization issues additional shares of common stock, it carries different implications on the existing shareholders. Common stock is a form of security that represents ownership in an organization, organization issue more common stock when they want to undertake expensive projects. Issuance of common stock is responsible for share dilution, such that the existing shareholders will have to share dividends with the new shareholders. While issuance of common stock increases the organization’s capital, it has the potential of reducing shareholder’s equity. Common stock is also accompanied by voting rights, and if a single new investor buys the new shares, the new investor’s voting rights can outnumber that of the existing shareholders. Therefore, issuance of common stocks can lead to loss of control among existing shareholders.
According to Plaehn (2011), the price of the stock in the market is often based on investor expectations, and depending on investors’ time frame issuing new stock might be viewed as a positive thing for the share price. The capital value will remain the same, however earnings per share will reduce for the existing investors.
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Alternatively, a share repurchase program is applied when a business feels that its share value is below the intrinsic value in the market place. According to Almeida et al. (2014), EPS- induced repurchase program have no negative effect on the shareholder value. In fact, a share repurchase program has the potential of increasing earnings per share as it reduces the number of outstanding shares in the market.
However, when the share repurchase program is not done right it can hurt the existing shareholders. In certain cases, buybacks have been done when the shares are not undervalued, and eventually shareholders lose their dividends because of management’s poor decision. In other incidences, buy backs have been done using credits, and this puts the organization and the remaining shareholders at risk. In other cases the repurchase program is motivated by executive greed. The executive management is often compensated by stock options, and sometimes they pursue new share repurchase program in the hopes of increasing the value of their shares. In such cases, if the company is buying back undervalued shares, it stands to benefit, however if the shares are overvalued the shareholder value is destroyed.
The increase of quarterly dividend per share is a positive thing to the existing shareholders, after all the role of the organization’s management is to maximize shareholder value. According to Matthew et al., (2014), shareholders are motivated by increased profits and dividends, however, increased dividends can also have negative effects on investment policy. Retained profits are deemed the cheapest form of capital, and increased dividends can reduce the organization’s capital.
The company can choose to increase the dividend per share for two reasons. First, when there is an increase in profit. With increased profits, organizations feel the need to share the success with shareholders by increasing dividends. Also, when there is a shift in the company’s growth strategy the company can decide to increase its dividends. A company might decide to spend less on growth and expansion, and instead reward shareholders with increased dividends. However, this might be viewed negatively by shareholders interested in the long term growth and profitability of the company.
References
Almeida, H., Fos, V., & Kronlund, M. (2016). The real effects of share repurchases. Journal of Financial Economics , 119 (1), 168-185.
Matthew, O.M., Enekwe, C.I, & Anyanwaokoro, M. (2014). Effect of Dividend Payment on the Market Price of Shares: A Study of Quoted Firms in Nigeria. Journal of Economics and Finance, 5 (4), 49-62.
Plaehn, T. (2011). What Happens to the Share Price When New Shares Are Issued? Zacks. Retrieved from:
http://finance.zacks.com/happens-share-price-new-shares-issued-7922.html
