In: Accounting
Can you explain how and why the value of shares are diluted when firms allow their employees to buy the firm's stock at a discount?
When the firms allow their employees to buy firm's stock option at a discount the share value becomes diliuted.Now how this dilution takes place can be explained with the help of following example:
Suppose the outstanding shares in a company is 100000 shares and the value of share is $ 100 per share.Now if the company issues 10000 shares more but not to the employees of company rather to outsiders without giving any discount at a rate of $100.So the number of shares outstanding will increase to 110,000 shares and the value of the whole company will be $11,000,000 i.e $100*110,000 shares which works out to $100 per share.But if the company issues 10000 share to the employees at a discounted price,suppose at $90 per share.Then the value of the company will increase from $10,000,000 to $10,900,000..But the shares outstanding will increase by the same number i.e 10000 shares.Now there would be 110000 shares outstanding.That works out to be $99.09 per share or a reduction in value of $0.91 i.e $100 - $99.09.
This shares value dilution take place when employees are allowed to buy stock at a discount and they excercise their options.When the shares are issued,firstly the number of outstanding shares increases.Secondly each employee stock holder owns a smaller,or diluted percentage of the company,making each share less valuable.