Complex capital structure

accounting

A complex capital structure is one in which there are potentially dilutive securities that can reduce earnings per share (EPS).

Within their own resources, companies can choose different types of securities to finance their activity. Some of these securities may be convertible into ordinary shares such as options, warrants or convertible securities of different types such as bonds or preferred shares.

Companies with complex capital structures have these securities to finance their activity, unlike simple capital structures. Depending on the moment in which they are, they can decide whether to convert some of them into ordinary shares or not. Therefore, a complex capital structure will contain both non-convertible securities and potentially dilutive convertible securities.

Although it is important to note that this is not always the case. Some securities such as convertible bonds for example, could increase the earnings per share derived from the cost savings that it would mean for the company to stop paying the interest on these bonds. In other words, even though more titles would be added to the capital structure, the interest savings would compensate for that greater number of titles.

Complex capital structure

The XYZ company has issued 10,000,000 titles. Net income is 60,000 and its capital structure is as follows:

  • 5,000,000 ordinary shares.
  • 2,000,000 non-convertible preferred shares with a dividend of 5% and a nominal value of € 100.
  • 3,000,000 bonds convertible into shares. These bonds are each converted into 2 shares, have a nominal value of € 1,000 and a coupon of 5%. The tax rate is 30%.

As we can see from the capital structure of the company, convertible bonds could have a dilutive effect on the EPS of the company. To check this, you would first have to calculate the EPS without converting the effect of the bond conversion and calculate the EPS again with the bond conversion. If when converting the bonds the EPS were lower, they would have a dilutive effect on it.

Optimal capital structure

The optimal capital structure has been widely studied by the branch of corporate finance.
The theoretical framework for the optimal capital structure was proposed by Modigliani and Miller. Although this theoretical framework assumes a somewhat ideal market (there are no taxes and the market is perfect), it has served for years as a basis for studying the impact of the capital structure on the value of the company.

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