Such being the reason why this outburst of capitalisation of reserves first began—­since in these days all capitalists and those who have to manage capital feel that they are working under criticism, which is not only jealous and suspicious (as it should be), but is also too often both ignorant and prejudiced—­it is interesting to note that the movement which was so started has been stimulated by its very exhilarating effect on the market in the shares of the companies concerned.  Why this should be so it is difficult at first sight to say.  What happens is merely this—­that a company, let us suppose, for the sake of simplicity, with a capital consisting wholly of 3,000,000 Ordinary shares, has accumulated out of past profits, or out of premiums on new issues of shares, a reserve fund of L1,000,000.  Its net profit has lately averaged L400,000, and it has, year by year, distributed L300,000 in the shape of a 10 per cent. dividend to its shareholders, and put L100,000 into its reserve fund, which is represented on the other side of the balance-sheet by buildings and plant and a certain amount of first-class investments.  If the directors now decide to capitalise that L1,000,000 of reserve fund, the only effect is that each shareholder will be given one new share for every three which he holds in the existing capital, the reserve fund will be wiped out, and the ordinary capital will be increased from L3,000,000 to L4,000,000.  None of the shareholders will be in actual fact better off to the extent of one halfpenny, because all will be in the same position with regard to one another; their relative shares in the enterprise will not have been altered.  If we imagine, by way of simplifying the problem, that all the Ordinary shares were in one hand, that one holder would have had in his Ordinary shares a claim to the total assets of the company, that is to say, to its earning power as long as it is a going concern, and to whatever its assets realise if it went into liquidation; the fact that L1,000,000 worth of the assets had been bought out of past profits or premiums paid on new issues of shares would have already added to the value of the claim that he had on the property of the company, and no addition would be made to that value by turning the reserve fund into shares.

In other words, the reserve fund is already the property of the shareholders, and to convert it from reserve fund into capital, making them a present of new shares, which merely represent their claim to the assets held against the reserve fund, is as empty a gift as presenting a man with a piece of paper informing him that he is the owner of his own hat.  All this remains equally true if, besides the ordinary capital, there is a considerable amount outstanding of Preference shares and Debenture debt.  In any case, the Ordinary shareholders possess a claim to the earning power of the company when prior charges have been satisfied, and to whatever surplus may remain on liquidation