28e: diluted EPS and dilutive events

CFA Level I FRA
#1

Is a dilutive event (such as people trading their debt instruments to common stock) always considered a negative thing because it reduces the proportion of power in the other remaining shareholders?

For example, let’s say you are the head of a company with 1,000,000 outstanding shares. The share price is 30 FMV and the corporate earnings were 3 million.

Right now, the market cap of the company is $30,000,000 and the EPS is $3.00

People who bought your companies’ bond years ago suddenly convert their debts to 200,000 new shares of common stock

So now, you have 1,200,000 outstanding shares, EPS of $2.50. What happens?

  1. Does the share price fall from $30 to $25 to keep the market cap at $30,000,000? Or does share price go up becaues now the company has less liability on the balance sheet?

  2. Are investors freaking out because now their share values and EPS went down?

  3. Or are shareholders happy because you’ve cleaned out some debt obligations?

#2

I think share price wouldn’t change. cos, the conversion of shares isn’t taking place on the exchange(If the company repurchases shares from the open market, they might influence price if the number of shares bought are large), therefore market cap increases (old price * increased number of shares). If anybody is to freak out, shareholders are the ones to freak out, as their earnings are being diluted. I think.