Essay on Shareholder Returns

Issuance of additional shares of common stock

Public companies exist to serve their shareholders’ needs (Hsu, Fung & Chang, 2016). When public companies make money, shareholders are happy and satisfied, and the profits are distributed accordingly. Also, it is the shareholders who sacrifice their earnings per share when a company seeks expansion. All in all, all actions by a corporation directly affect shareholders. One known corporate step that directly affects shareholders is issuing additional shares. Companies issue additional shares to the market for different reasons, but one of the main reasons is to raise money from investors.

When a company issues extra shares, the volume of common stock exchanged in the market rises (Hsu, Fung & Chang, 2016). Often this move triggers an adverse effect on existing shares. For investors, too many shares in the market lead to share dilution. In other words, selling more securities on the market decreases the value for holders of current shares. Consider a company with 100 shares outstanding, and one investor owns ten percent of the shares. If the business issues another 100 shares, the investor’s stake will reduce by half to 5 percent since they own five shares out of the possible 200 shares. In other words, the investor’s stock will be diluted by the newly issued shares.

Apart from diluting the value of existing shares issuing new shares would negatively affect earnings per share (Khan et al., 2014). It would decrease a company’s earnings per share (EPS). For instance, company A wants to raise money. The only way this can happen is to issue additional 5 million shares to be sold in the market. If company A initially had 10 million outstanding shares and recorded a profit of 2 million dollars, it would attain an ESP of 20 cents (2 million dollars divided by 10 million shares). But the additional 5 million shares increased the number of existing shares to 15 million; therefore, EPS would decrease to 13 cents per share (2 million dollars divided by 15 million shares. Any change in EPS is noteworthy. EPS is also a closely watched metric that shareholders, and company executives use to foretell future profitability.

Announcement of A New Share Repurchase Program

A share repurchase program is the vice versa of issuance of additional shares. A share repurchase program or a share buyback is when a company forms initiatives to acquire its shares from shareholders (Edgerton, 2013). There are many reasons why companies engage in a share buyback. First, McLean (2011) view buyback as the best use of capital after all the objectives of a company’s management is to maximize returns for its shareholders. A share repurchase program would increase shareholder value. Most companies about to engage in a buyback program would state, “…we do not see any better investment than in ourselves…” (Greenwood & Hanson, 2012). Even though this may be the case, the same statement may not always be accurate. However, it is essential to understand that share repurchase programs affect shareholders differently.

A share buyback programs drive value for shareholders (Welch, 2011). Consider the example above. Issuing 100 shares to the market with 100 outstanding shares decreased the investor’s stock value by half (from 10 percent to 5 percent). A share repurchase program would trigger a reverse effect; rather than reducing the value of existing shares, it would increase the value. Repurchase programs also affect EPS. Since a share repurchase reduces a company’s total outstanding shares, a significant impact may be seen in per share measures of profitability and cash flow, including EPS (Greenwood & Hanson, 2012). The buyback could ultimately lead to a more significant share price because the price-earnings (P/E) multiple at which the stock trades remain unchanged.

Consider a hypothetical company B. Company B had 100 million outstanding shares in January. The shares were traded at 10 dollars, which gave company B a market capitalization (market cap) of 0ne billion dollars. The company attained a net income of 50 million dollars or an EPS of 50 cents per share (50 million dollars divided by 100 million outstanding shares) in the preceding months. This means that company B’s stock was trading a P/E multiple of 20 times (10 dollars divided by 50 cents). Share repurchase may increase the value of outstanding shares, which may make more investors want to sell. It may also make others retain their stock with the hope that the value would rise. Importantly, a share repurchase would allow the company’s stock to attract a higher price. For instance, if company B were initially trading its shares at 10 dollars, a repurchase would see the price increase to about 20 dollars.

Increase of The Quarterly Dividend Per Share

Another instance that affects the market and shareholders is dividends. Dividends can affect the value and the price of an underlying stock differently (Dong, Wang & Xie, 2010). A public company often declares the dividend amount and the date before they issue or distribute a dividend. The company announces the last date when the share will be purchased in order to receive the dividend. The declaration of dividends often encourages investors to buy stock (Malik et al., 2013). Since shareholders understand that if they buy the stock before the ex-dividend date, they will earn a dividend, they are willing to pay extra. This activity results in a rise in stock prices in the days prior to the ex-dividend date.

When dividend per share increases, the stock’s value might or might not rise (Al-Yahyaee, Pham & Walter, 2011). The price often rises when many investors decide to keep their shares, an instance that increases demands in days before the ex-dividend date. However, when many investors choose to sell in a few days close to the ex-dividend date, the prices may remain or decrease further. An increase in dividend per share may also mean an increase in a company’s net profit, out of which dividends are paid (Bhattacharya & Jacobsen, 2016). If companies are performing well, they pay their shareholders more dividends. In this context, an increase in dividends is a positive indicator that the company is doing well. The market understands this aspect; therefore, when investors see a company increase its dividends, they increasingly buy the company’s shares.

A sustainable overtime dividend payout is a positive sign for investors (Al-Yahyaee, Pham & Walter, 2011). This suggests a financially sound business with revenues favorable to sustain continued dividend earnings. All in all, companies with increased dividend payout are believed to be profitable; they send a positive signal to investors that the business can maintain growth and consistent income into the future. Dividends increase attracts investors seeking additional income, an instance that positively affects the value of outstanding shares. An increase in demand triggers an increase in stock value.

References

Al-Yahyaee, K. H., Pham, T. M., & Walter, T. S. (2011). The information content of cash dividend announcements in a unique environment. Journal of Banking & Finance, 35(3), 606-612.

Bhattacharya, U., & E. Jacobsen, S. (2016). The share repurchases announcement puzzle: Theory and evidence. Review of Finance, 20(2), 725-758.

Dong, Z., Wang, C., & Xie, F. (2010). Do executive stock options induce excessive risk taking? Journal of Banking & Finance, 34(10), 2518-2529.

Edgerton, J. (2013). Four facts about dividend payouts and the 2003 tax cut. International Tax and Public Finance, 20(5), 769-784.

Greenwood, R., & Hanson, S. G. (2012). Share issuance and factor timing. The Journal of Finance, 67(2), 761-798.

Hsu, C. H., Fung, H. G., & Chang, Y. P. (2016). The performance of Taiwanese firms after a share repurchase announcement. Review of Quantitative Finance and Accounting, 47(4), 1251-1269.

Khan, T. R., Islam, M., Choudhury, T. T., & Adnan, A. M. (2014). How earning per share (EPS) affects on share price and firm value.

Malik, F., Gul, S., Khan, M. T., Rehman, S. U., & Khan, M. (2013). Factors influencing corporate dividend payout decisions of financial and non-financial firms. Research Journal of Finance and Accounting, 4(1), 35-46.

McLean, R. D. (2011). Share issuance and cash savings. Journal of Financial Economics, 99(3), 693-715.

Welch, I. (2011). Two common problems in capital structure research: The financial‐debt‐to‐asset ratio and issuing activity versus leverage changes. International Review of Finance, 11(1), 1-17.