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Definition: Anti-dilutive

The term describes transactions by which earnings per share is increased for the shareholder. Transactions can have an anti-dilutive effect on the earnings per share either by lowering the share count or by increasing earnings or when the increase to earnings is more than the proportional increase to the number of shares outstanding. These transaction could include conversion of bonds, securities or common stock equivalents, security retirement, corporate actions such as acquisition made by issuing stocks or securities.

Anti-dilutive securities are financial instruments, which if converted to common stocks may increase corporation's EPS. Such conversion are not counted in calculating earnings per share. This is based on conservatism principle. The principle requires that the EPS should not be inflated by anti-dilutive effects.

In common and preferred stock in order to maintain the percent of ownership if the company issues more stocks and to protect devaluation of the shares held by the investor, anti-dilution provision gives the investor the right to buy shares in the new round of financing up to his previous percentage of ownership. The buying will take place at the offering price.

Eg 1. if a convertible high yielding bond is converted to common stock, it will increase the number of outstanding shares by conversion ratio, and net earnings will increase by the amount of interest saved on the bonds. A bond with low interest rate and high coupon rate will increase EPS and the effect of the conversion will be anti-dilutive.

Eg 2. anti dilution clause help the investor maintain the conversion ratio in case of a stock split. if a convertible bond can be exchanged with 100 shares and there is a 3 for 1 split, the same bond will now be exchanged for 300 shares. This maintains the valuation of conversion option.

Eg 3. Business transaction can also cause anti-dilutive effect. If company X acquires company Y using the common stocks, the earnings of Company Y is added to those of Company X and if earning add more to EPS than he issued common stock, it is an anti-dilutive acquisition.



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