Many investors in the stock market look positively at the joint-stock company that distributes shares to its shareholders instead of cash distributions, believing that the company’s use of its profits in expansion projects serves the growth of its profits and thus contributes to increasing their wealth as shareholders. And they are right about that, but the matter does not always end as they aspire. There are many companies that have adopted this policy, but it has not reflected positively on increasing the wealth of shareholders.

As an investor in the stock market, especially the small shareholder and minority shareholder, it is better, when the company whose shares you own decides to give you additional shares instead of cash dividends, to stop a little and review the company’s decision and make sure that it is directly in the interest of improving the company’s financial profits and returns. Basically, and that it has no other goals.

What are the possible cases of distributing a share bonus that is not in the interest of the shareholders?

The executive management of the company is looking out for its own interests

Mostly, there are two main goals behind the management’s desire to increase the company’s capital through distributions through a share bonus. The first reason is related to their personal interests and increasing their wealth by increasing the company’s budget and increasing their financial advantages and other preferential features. The second reason is related to their desire to influence the company’s board of directors (or control it indirectly), which enables them to control the fate of the company and the shareholders due to the absence of the principle of “control and accountability” or what is called in English (Checks & Balances).

The increase in the number of shares as a result of stock bonus distributions prompts some shareholders to sell these shares to the public with the aim of converting them into cash dividends. As a result, the company’s shareholder base increases, but their ownership gradually decreases. With each time a new share grant is distributed, the number of shareholders who own more than 5% of the company’s shares decreases, and it becomes difficult for shareholders to form any bloc against the decisions of the executive management.

Big investors want to control the company’s fate

Major investors are not always bad, as some companies succeeded thanks to the keenness of major investors on the interests of all shareholders, but the distribution of bonus shares is one of the means they use to control the fate of the company and its resources, just like the executive management. Mostly, the objectives of the major investors become clear when the company’s financial performance is negatively affected and there are related dealings with the company, or when there is a conflict of interests for the members of the board of directors nominated by them with the interests of the company and the shareholders.

Related transactions are not always bad, as they are beneficial when they provide the company with a comparative advantage that contributes to raising its profitability rates and financial stability during crises. If it does not provide these features, then it is considered an exploitation of the company’s resources for the personal interest of the relevant party. This information can be accessed through the periodic reports issued by the company, whether on the Tadawul website or on its main website.

The decision itself is wrong (the company’s strategy to increase capital is not appropriate).

Do not forget to review the expansion decision analytically to ensure its financial feasibility in the first place, as sometimes the decision is wrong in itself. When analyzing the decision commercially, there are several methods that can be used to do so, including industry analysis and business environment analysis (PESTLE), legal, political, economic, environmental, etc.

For example, if the industry (or sector) is in the maturity stage of its life cycle, this means that there are great risks for expansion. The next stage of the sector’s life cycle will be contraction, which means lower sales and increased competition. Also, when the economy in general is in income or will enter into a stage of stagnation and deflation, it would be wrong to take the decision to expand at this moment, especially if this has a direct impact on the growth of the sector in which the company sells its products or provides its services.