In the ever-changing world of corporate finance, businesses may use calculated moves to lower the Fair Market Value (FMV) of their stock. A number of factors, from tax optimization and financial restructuring to increasing attractiveness for possible investors or acquisition targets, may influence this well-considered choice. Companies seek to negotiate regulatory environments, enhance financial indicators, and seize possibilities for development and profitability by purposefully lowering the FMV.
Why do companies opt for decreasing its shares FMV ? – Results of lowering shares FMV
- Tax Optimization: Reducing the FMV of shares can lead to lower tax liabilities for shareholders.
- Attractive Valuation: A decreased FMV can make shares appear more attractively priced to potential investors.
- Acquisition Opportunities: Companies may strategically decrease the FMV of their shares to make themselves more attractive targets for acquisition.
- Financial Reporting: A lower valuation may result in reduced asset values, which can improve financial ratios such as price-to-book ratio or price-to-earnings ratio, making the company appear more financially sound to investors and creditors.
- Avoiding Regulatory Scrutiny: Sometimes a high FMV of shares can draw unwelcome attention from stakeholders or regulatory examination. Companies can reduce the risks related to investor activism or regulatory compliance by lowering the FMV.
In summary, Decreasing FMV have various benefits such as share buybacks present opportunities for companies to repurchase undervalued shares, potentially boosting earnings per share and shareholder value. Furthermore, the resulting enhanced dividend yield may attract income-oriented investors, and lower share prices can make the company more attractive for strategic acquisitions, potentially leading to premium buyout offers.
Reducing the FMV of shares is a challenging task. There are various ways to go about it, but the two most popular ones are bonus shares and stock split.
1. BONUS ISSUE
A bonus issue’s effect on the price per share and the company’s total market capitalization establishes a connection between it and the fair market value (FMV) of shares. The following is how a bonus issue impacts the shares’ FMV:
♦ Bonus shares are free extra shares that are issued to current shareholders by the corporation. As a result, the market valuation of the company stays the same but the total number of shares outstanding rises.
♦ Since the value of the company is now distributed over a greater number of shares, the price per share falls correspondingly.
♦ In conclusion, a bonus issue influences the market capitalization of the firm and the price per share, which in turn influences the FMV of shares indirectly. The impact on the fair market value (FMV) is contingent upon investors’ interpretation of the bonus problem in light of the company’s overall performance and prospects, even though it may lead to a decline in the price per share.
♦ Bonus shares are issued from :- When a company generates profits, it may choose to retain a portion of those earnings rather than distributing them all as dividends to shareholders. A portion of these retained earnings can be utilized to issue bonus shares. Companies may also have surplus reserves, which can also be used for issuing bonus shares.
Example:- Company ABC has 1,00,000 outstanding shares, and its current FMV per share is $100. This puts the company’s total market capitalization at $1,00,00,000. Let’s now assume that Company ABC decides to offer a 1:1 bonus, which means that shareholders will get one extra share for free for each share they now own.
| Particulars | Before issue | After issue |
| No of Outstanding shares | 100000 shares | 200000 shares |
| Market Capitalization | $1,00,00,000 | $1,00,00,000 |
| FMV per share | $1,00,00,000/1,00,000
= $100 per share |
$1,00,00,000/2,00,000
= $50 per share |
2. STOCK SPLIT
A stock split is a corporate action where a company increases the number of its outstanding shares by dividing its existing shares into multiple shares. The primary purpose of a stock split is to make shares more affordable and increase liquidity in the market. The linkage between a stock split and the fair market value (FMV) of shares is similar to that of a bonus issue. Here’s how a stock split affects the FMV of shares:
♦ A stock split is a corporate action whereby a corporation divides its existing shares into multiple shares, hence increasing the number of outstanding shares while preserving the company’s total market value. A 2-for-1 stock split, for instance, essentially halves the price per share by giving each shareholder two shares for every share they now own.
♦ A stock split has no effect on the company’s overall market value. Because the price per share falls proportionately even as the number of outstanding shares increases, the market capitalization stays the same.
♦ A stock split affects the FMV of shares indirectly by altering the price per share and the company’s market capitalization.
(The example for stock split can be same as bonus issue)
♦ Difference between Bonus and Stock split
| Aspect | Bonus Issue | Stock split |
| Definition | Additional shares are issued to existing shareholders. | Existing shares are divided into multiple shares. |
| Impact on Price | No change in price per share (Change in FMV per share) | Decreases the price per share proportionally. |
| Shareholder Benefit | Receives additional shares without cost. | Receives more shares at a lower price per share. |
| Example | Original: 1 share at Rs 100 -> After 1:1 bonus: 2 shares at Rs 100 | Original: 1 share at Rs 100 -> After 2-for-1 split: 2 shares at Rs 50 |
| FMV :- 2 shares at Rs 100 | FMV :- 2 shares at Rs 100 |
3. Reporting
♦ Announcement: Through a press release or a regulatory filing, the company notifies the public of its plan to issue bonus shares or stock split. Information like the bonus share ratio, stock split ratio, the source of the shares (reserves or retained earnings, for example), and the record date for identifying eligible shareholders are all included in the announcement.
♦ Notice to Shareholders: The business notifies shareholders via a circular all the information they need to know about the plan, including the reasoning behind the choice, how it will affect shareholding, and any pertinent dates.
♦ Regulatory Documentation: To comply with disclosure obligations, the company files the required documentation with regulatory bodies, such as the Securities and Exchange Board of India or any other applicable stock exchanges
♦ Accounting Treatment: The business makes adjustments to its financial statements to account for any bonus shares or split shares issued as well as any.
Conclusion: Reducing the FMV of shares presents various strategic benefits for companies, including tax optimization, making shares more attractive to investors, and improving financial ratios. Techniques such as issuing bonus shares and performing stock splits are common methods to achieve these goals. By understanding and utilizing these strategies, companies can enhance shareholder value, attract potential buyers, and better position themselves within the market.
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Author: Vansh Shah, Associate Consultant; Email: blogs@bilimoriamehta.com; Contact: +91 98709 25375
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