Updated July 15, 2023
Introduction of Anti Dilutive Securities
The term Anti Dilutive generally used for convertible preference shares and convertible debentures (not used for ordinary shares), which impact 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 do not use in the computation of diluted EPS.
Explanation
These are financing instruments not in the form of ordinary shares or securities at their initial stage. These are generally convertible securities, and converting them into ordinary shares resulted in increased EPS or maintenance of their control on the securities. EPS depends on Net earnings and the Total number of outstanding shares. So due to the conversion of anti dilutive securities, net earnings increase, or the number of outstanding shares decreases, increasing EPS. Dilutes EPS calculate when convertible securities. Stock options include in the company’s capital structure to show how the earnings per share affect if all the outstanding shares are issued.
Example of Anti DilutiveSecurities
From an example, let’s understand how to compute that the securities are anti dilutive.
For Example, Company Q has issued 1000, 20%convertible debentures at $250 per debenture at par. Company Q has stated that debenture holders 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 calculates as
First of all, we have to find the preference dividend
Preference Dividend calculates as
- 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 states that the debenture holder can get 10 shares per debenture, with 1,000 debentures. So ordinary shares resulting 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 calculates as
- 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, Anti dilutive securities are excluded from the computation of diluted EPS. The shortcut formula for checking whether the convertible security is Anti dilutive is:
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 include in the computation of Diluted EPS, but Anti Dilutive Securities are not included in Diluted EPS’s analysis.
Advantages of Anti Dilutive Securities
It results in the maintenance or enhancement of the ownership rights of the securities holder. It allows the holder 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 holders enhances as their earnings per share will not 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, two types of securities are 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 common shares, if their interest in ownership remains intact or increases or there is an increase in EPS, these securities consider as Anti Dilutive securities. And if it results in a reduction of EPS, then it is considered dilutive securities. The company’s balance sheet shows EPS and diluted EPS based on which investors decide to invest.
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, the convertible security is anti dilutive security. The convertible security is dilutive when the normal EPS is less than the Diluted one.
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