But since, as has been shown, capitalisation of reserves has no effect upon the earning power and assets of the company, it is interesting to try and discover why the rumour and announcement of such an intention on the part of the board of directors is nearly always accompanied by a rise in the shares of the company affected.  If the shareholder is merely to be given a larger nominal claim, which does not in the least affect the value of the assets which that claim concerns, and if the relative amount of his claim is exactly the same with regard to the other shareholders, it is clear that the rise in the value of the shares is based entirely either on a psychological mistake on the part of the public and its financial advisers, or on the fact that the transaction called attention to the value of the shares which have hitherto been undervalued in the market.  Probably the movement arises from both these causes.  A large number of people think they are better off if they have a larger nominal share, without considering that all the other shareholders are at the same time having their claim increased, that the assets to which they all have a claim are not being increased, and that, consequently, if a sharing-out process were to take place they would all be exactly as they would have been if no such capitalisation of reserves had been carried out.  And if a sufficient number of people think that a share or any other commodity is more valuable, it thereby becomes more valuable, because value is nothing else than the amount, whether in money or other commodities, at which a commodity can be disposed of.

But it is also true that there are, at all times, a very large number of securities, especially in the industrial market, which would stand higher if their earning power and position were more closely scrutinised.  This is very clearly seen to be the case from the apparently extravagant prices at which insurance companies, for example, sometimes buy the businesses of one another.  They give a price which is considerably above the market value of the concern as represented by the price of its shares.  Critics say that the terms are extravagant, and yet the deal is found to be highly profitable to the buying company.  The profit of the deal, of course, may be increased by the advantages of amalgamation, but quite apart from that it is clear that the market price of securities very often undervalues, as it also, perhaps, still oftener overvalues, the real position of the companies on whose earning powers they represent claims.  In any case, there is the fact that these capitalisations of reserve funds, which make no real difference to the actual position of the company, are universally regarded, in the language of the Stock Exchange, as “bull points.”  It is assumed, of course, that the directors would not carry out such an operation unless they saw their way to a higher earning power in the future as a justification for the larger capital.  In this expectation the directors might be right or wrong, and, even if they are right, that prospect of higher earning power, if market prices could be relied upon to express the true position of a company, would have been “in the price.”