The capital of a company is divided into shares.
Each share forms a unit of ownership of a company and is offered for sale so as to raise capital for the company.
The holders of shares are called shareholders.
Shares are of two types- ordinary or equity shares and preference shares
What are ordinary/equity shares?
- They are the legal owners of the company.
- Ordinary shares are source of permanent capital since they don’t have maturity date.
- Shareholders are entitled to receive dividends by the company.
- The amount or rate of dividend is not fixed. It is decided by the company’s board of directors.
- Ordinary share is also known as a variable income security.
What are the features of equity shares?
Claim on income
Ordinary shareholders have a residual ownership claim.
Residual income is earnings available after paying expenses, interest charges, taxes, preference dividend, if any.
This residual income is either directly distributed to shareholders in the form of dividends or indirectly in the form of retained earnings which are reinvested in the business.
Retained earnings help in growth of the company, which is beneficial for the shareholders.
Claim on assets
On liquidation of the company, dues are paid to debt holders, preference shareholders and the remaining is paid to ordinary shareholders.
Right to control
Ordinary shareholders have the legal power to elect directors on board.
Board of directors approve major policies of the company and appoint managers to carry out day to day operations.
Thus, ordinary shareholders can control the management of company by choosing board of directors.
Ordinary shareholders have the right to vote on major decisions of the company eg. Change in memorandum of association, election of board of directors, etc.
An ordinary shareholder has votes equal to the number of shares held by him.
Liability of ordinary shareholders is limited to the amount of their investment in shares. In case of liquidation or any financial problem, ordinary shareholders are not liable to pay.
What are the advantages of equity shares?
Shareholders’ Point of View
- Liquidity and easily traded in capital market
- Higher dividends when company has increased profit
- Voting rights to control management of the company
- Appreciation in the value of shares when company performs well
Company’s Point of View:
- Least repayment liability
- Permanent source of capital
- No obligation to pay dividend
What are the disadvantages of equity shares?
Shareholders’ Point of View:
- Uncertainty of receiving dividend
- Fluctuations in value of shares
- Issue of fresh shares reduces the earnings of existing shareholders
Company’s Point of View:
- High cost to source equity shares as compared to other sources of finance
- Payment of dividend is not tax deductible
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