Introduction of Anti Dilutive Securities
The term Anti Dilutive is generally used for convertible preference share and convertible debentures (not used for ordinary shares), which are impacted by the conversion of securities, the retirement of securities, other activities in corporate, etc. and the exercise of which results in maintained EPS or an increased EPS by reducing the Company’s total no. of outstanding shares or increasing the net earning and these anti dilutive activities are not used in the computation of diluted EPS.
Explanation
Anti dilutive securities are those financing instrument which is not in the form of ordinary shares or securities at its initial stage. These are generally in the form of convertible securities, and the conversion of which into ordinary shares resulted in an increase of EPS or maintenance of their control on the securities. Basically, EPS is dependent on two factors that are Net earnings and the Total number of outstanding shares. So due to the conversion of anti dilutive securities, net earnings are increased, or the number of outstanding shares is decreased resulted in an increase in EPS. Diluted EPS is calculated when convertible securities. Stock options are included in the company’s capital structure to show how the earnings per share are affected if all the outstanding shares are issued.
Example of Anti DilutiveSecurities
Let’s understand how to compute that the securities are anti dilutive from an example.
For Example, Company Q has issued 1000, 20%convertible debentures at $250 per debenture at par. Company Q has stated that debenture holder can get 10 shares per debenture at the time of conversion. The information is given below:
| Total number of outstanding shares (ordinary shares) | 70000 |
| Net Earnings | $240,000 |
| 15% preference shares | $200,000 |
| Tax Rate | 30% |
Compute Basic and Diluted EPS. Compare them.
Basic EPS is calculated as
Basic EPS = (Net Earnings-Preference Dividend Paid) / Total Number of Outstanding Shares
First of all, we have to find preference dividend
Preference Dividend is calculated as
Preference Dividend = Value of Preference Share * Interest Rate
- Preference Dividend = $200,000*15%
- Preference Dividend = $30,000
So, Basic EPS= (Net Earnings-Preference Dividend Paid) / Total Number of Outstanding Shares
- Basic EPS = ($240000 – $30000) / 70,000
- Basic EPS = $3 per share
Computation of Diluted EPS
For computing Diluted EPS, we have to compute many ordinary shares resulting from the conversion of debentures.
It is stated that debenture holder can get 10 shares per debenture, and there are 1,000 debentures. So ordinary shares resulted from the conversion of debentures are 10,000 shares (1,000*10). Secondly, we have to compute proceeds, i.e., interest income from convertible debentures that is
= [ (number of Debentures *price per Debenture) * Interest Rate * (1- Tax Rate)]
- = [ (1000 * 250) * 20% * (1 -.03)]
- = $35,000
Diluted EPS is calculated as
Diluted EPS = (Net Earnings-Preference Share Dividend+ Proceeds from Convertible Debentures) / Total Number of Outstanding Shares+ Ordinary Shares Resulted from The Conversion of Debentures.
- Diluted EPS = ($240,000 – $30,000 + $35,000) / (70,000 + 10,000)
- Diluted EPS = $ 3.0625 per share
When Diluted EPS>Bsic EPS, Then it is Anti Dilutive Securities. In the given scenario, the convertible debentures are antidilutive securities as the dilutive EPS (i.e., $3.0625 per share) is more than Basic EPS (i.e.,$3 per share So, for the computation of diluted EPS, Anti dilutive securities are excluded. The shortcut formula for checking whether the convertible security is Anti dilutive is:
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For Convertible Debentures
Convertible debentures earnings/Proceeds/interest * (100-Tax rate percentage)
Number of ordinary shares obtained on the conversion of debentures
- IF the result of the above formula < Basic EPS, then dilutive security and included in the computation of Diluted EPS.
- IF the result of the above formula > Basic EPS, then Anti dilutive security and not included in the computation of Diluted EPS.
For Convertible Preference Share
Convertible preference share dividend
No. of ordinary shares obtained on conversion
- IF the result of the above formula < Basic EPS, then dilutive security and included in the computation of Diluted EPS.
- IF the result of the above formula > Basic EPS, then Anti dilutive security and not included in the computation of Diluted EPS.
Difference between Dilutive Securities and Anti Dilutive Securities
Due to the effect of Anti dilutive Securities, EPS increases but due to the effect of dilutive securities, EPS reduces. Dilutive securities are included in the computation of Diluted EPS, but Anti Dilutive Securities are not included in Diluted EPS’s computation.
Advantages of Anti Dilutive Securities
It results in the maintenance or enhancement of the ownership rights of the securities holder. It provides the holder with an option to acquire other securities in the future when their interest in ownership is diluted. It results in either increase in EPS or Maintenance of EPS. By investing in Anti Dilutive security, the confidence of securities holder enhances as their earnings per share is not going to reduce.
Diluted EPS is also shown in the balance sheet along with basic EPS to show the effect on earnings per share if all the outstanding shares have been issued. Based on diluted EPS, investors would invest in the company. So to calculate correct Diluted EPS, anti-dilutive securities are not included. This will help to show fair and true Diluted EPS.
Conclusion
Thus, there are two types of securities that is Dilutive securities and Anti Dilutive Securities. Initially, these securities do not involve ordinary shares like equity shares. It involves convertible debentures, convertible preference shares etc. On converting these shares into ordinary shares, if their interest in ownership remains intact or increases or there is an increase of EPS, these securities are considered to be Anti Dilutive securities. And if it results in a reduction of EPS, then it is considered to be dilutive securities. EPS and diluted EPS are both shown in the Balance sheet of the company based on which investors take their decision to invest in the company. Higher EPS means higher profit to the investors. So Anti dilutive securities are not involved in the computation of Diluted EPS, but dilutive securities are included in the computation of Diluted EPS. This will show how the EPS has been affected if all the outstanding shares have been issued. When normal EPS is more than Diluted one, then the convertible security is anti dilutive security, and when normal EPS is less than Diluted one, then the convertible security is dilutive security.
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