Corporate Finance Theory and Practice, Third Edition

Chapter 39

SHARE ISSUES

There are no victories at bargain prices

The previous chapters have already begun our study of equity financing. This chapter analyses the consequences for the shareholder of a share issue (or capital increase). Capital increases resulting from mergers and acquisitions will be dealt with in Chapter 44.

Section 39.1

A DEFINITION OF A SHARE ISSUE

1/ A SHARE ISSUE IS A SALE OF SHARES …

A share issue is, first of all, a sale of shares. But who is the seller? The current shareholder. The paradox is that the seller receives no money. As we shall see in this chapter, to avoid diluting his stake in the company at the time of a share issue, the shareholder must subscribe to the same proportion of the new issue that he holds of the pre-existing shares. Only if he subscribes to more than that is he (from the standpoint of his own portfolio) buying additional control; if less, he is selling control.

Up to now, we have presented market value as a sanction on the company's management, an external judgement that the company can ignore so long as its shareholders are not selling out and it is not asking them to stump up more money. A share issue, which conceptually is a sale of shares at market value, has the effect of reintroducing this value-sanction via the company's treasury, i.e. its cash balance. For the first time, market value, previously an external datum, interferes in the management of the company.

2/ … THE PROCEEDS OF WHICH GO TO THE COMPANY, AND THUS INDIRECTLY ...