When would a company prefer to split stocks or do a financial gearing capital restructure?
June 22nd, 2009 Ugonna Maduagufor || ugonna@stockmarketnigeria.com
Whenever company directors come up with a stock-split proposal, they
- (most often) see something good in it for the shareholders
- (rarely) obliged to do so statutorily or by a court action.
The reasons for this could be for any of the following:
- To take advantage of a bullish market: There are times that the market gets so bullish that it will blindly multiply investors share value, ignoring the stock-split (the market prices are initially adjusted by the market operators to ensure that the market capitalization remained same as the last trading day before the split).
- To increase the marketability of the stock:It is reasonable to split stocks when the demand perpetually surpasses its tradeable issued and fully paid share capital, especially in a growing market.
- Take overs: It could also be a means of fighting or guarding against a market take-over.
A stock split generally promotes marketability, equity book-value remains unchanged; while the market value per share responds to market forces of demand and supply, so good for a bullish market.
What of an increased financial gearing, capital re-structure?
When the directors anticipate a long term inflationary trend in the economy, one of the things they could do to improve the chances of wealth gain due to the inflation is increasing the company’s financial gearing, thereby increasing its financial leverage position. This would affect the company’s financial structure by decreasing the equity-to-fixed debt ratio. Most companies would not take the financial risk attached to floating bonds, if not in anticipation of raking in extra profit at the expense of other peoples (bond holder) monies.
Fixed interest (debt) capital is rarely free, it will always call for interest payment; charged on the trading, profit and loss account. If the company directors considers the large scale operation gains due to an increase in debt-capital, to be greater than the cost of fixed interest (debt) capital, then the economy is most likely experiencing an inflation; it is then wise to favor the shareholders by asking for any reasonable form of fixed interest debt providers funds.
The motives for increasing a companies financial gearing could be:
- To lock in low interest long term debt instrument funds. This is achieved by floating long term callable bonds in periods of low inflation rate, when the interest rates are low, with the intention of locking-in the cheap funds in future periods when the interest rates rises again, or call back the securities if the rates eventually moves downwards in future
- To avoid dilution of shares (control) that may occur if it floats more of its authorised ordinary shares capital
- To cut down on income taxation, by utilising the tax relief benefits of debt instruments.
Financial gearing is particularly good for corporate business entities whenever interest rates and inflationary rates are both expected to accelerate for a long time; thereby increasing earnings per share (EPS).
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