Final answer:
Dilution of earnings mainly occurs due to an increase in the number of outstanding shares, leading to a decrease in earnings per share. Distributing dividends and decreases in net income do not directly cause dilution. Instead, dilution affects shareholders' stake in a company when more shares are issued. So, the correct answer is option 2.
Step-by-step explanation:
Dilution of earnings occurs when the number of outstanding shares in a company increases, which can result from a company issuing more shares to raise capital. This increase in the share count spreads the company's earnings over a larger number of shares, which leads to a decrease in earnings per share (EPS).
However, offering dividends or a company experiencing a decrease in net income doesn't directly dilute earnings per share but may affect the overall financial health and investment appeal of the company.
When a company is owned by a large number of shareholders, critical questions include how and when the company gets money from the sale of its stock, the rate of return promised to shareholders, and who makes decisions in the company.
When a company sells stock, it's dividing ownership among a (potentially) large pool of investors, and the initial sale of the stock provides capital to the company without the obligation to repay, unlike a loan. Profits may be shared with shareholders through dividends, with the amount received directly proportional to the number of shares owned. However, distributing dividends is not the same as dilution; it is a sharing of profits rather than expanding the number of shares.
Decision-making in such companies typically resides with a board of directors who make significant decisions on matters like dividend payouts or reinvestment strategies. Ultimately, existing shareholders might face dilution of their ownership if the company issues more stock.