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ACCA Strategic Professional · Advanced Financial Management · Financial reconstruction

Which of the following is the most likely reason existing shareholders in a distressed company may agree to a scheme that dilutes their holding heavily?

Shareholders may accept heavy dilution because ordinary shareholders rank last and would probably get nothing on liquidation. A smaller holding in a company that survives has positive value, so it is better than the alternative of failure.

  1. AShareholders always receive priority over creditors on liquidation, so dilution is costless
  2. BWithout the scheme the company would be liquidated and ordinary shareholders would probably receive nothing, so a smaller stake in a surviving company is worth moreCorrect
  3. CDilution automatically increases earnings per share
  4. DCompany law requires shareholders to accept any scheme approved by creditors

Explanation

Ordinary shareholders rank last on liquidation and typically get nothing when assets do not cover debts. A diluted stake in a continuing company retains option-like value, so it beats the liquidation outcome. Shareholders do not rank ahead of creditors.

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