How does equity dilution occur?

Equity dilution occurs when a company issues additional shares, which reduces the ownership percentage of existing shareholders. This situation arises in various scenarios, such as raising new capital through a public offering or issuing stock options to employees. When new shares are created and sold to investors, the total number of shares outstanding increases, thereby diluting the stake that existing shareholders have in the company.

For existing shareholders, this dilution can mean a reduced percentage of ownership, which may lead to a decrease in their voting power and a smaller piece of future earnings distributed through dividends or capital gains. It’s critical for companies to manage share issuance carefully to avoid negatively impacting existing shareholders’ interests.

The other options do not involve issuing new shares; dividends distribute profits to shareholders but do not affect ownership percentages, share repurchases reduce the number of outstanding shares, which can actually increase ownership percentages for remaining shareholders, and a rise in stock price reflects market conditions rather than changes in ownership structure.