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Dilution occurs when a company issues additional shares of stock, and as a result the earnings per share and the book value per share decline.
This happens because earnings per share and book value per share are calculated by dividing the total earnings or book value by the number of existing shares.
The larger the number of shares, the lower the value of each share. Lower earnings per share may trigger a selloff in the stock, lowering its price. That's one reason a company may choose to issue bonds rather than new stock to raise additional capital.
Similarly, if companies merge or one buys another, earnings may be diluted if they don't increase proportionately with the combined number of shares in the newly created company.
Dilution can also occur if warrants and stock options on a stock are exercised, and if convertible bonds and preferred stock the company issued are converted to common stock.
Companies must report the worst-case potential for such dilution, or loss of value, to their shareholders as diluted earnings per share.
- the decrease in control and EARNINGS PER SHARE experienced by existing shareholders in a JOINT-STOCK COMPANY when SHARE ISSUES are made which attract new shareholders. Dilution is a particular problem in fast-growing, family-controlled companies where the need to raise new capital may dilute the founding family's shareholdings to below 50%, causing them to lose potential control of the company.
- the weakening of the monopoly of skills of a particular occupational group by the recruitment of less-skilled workers to perform the same work. See SKILL.