The merits and demerits of equity shares as a source of finance.

Equity shares or ordinary shares are those shares which are not preference shares. Dividend on these shares is paid after the fixed rate of dividend has been paid on preference shares. The rate of dividend on equity shares is not fixed and depends upon the profits available and the intention of the board. In case of winding up of the available and the intention of the board. In case of winding up of the company, equity capital can be paid back only after every other claim including the claim of preference shareholders has been settled. The most outstanding feature of equity capital is that its holders control the affairs of the company and have an unlimited interest in the company’s profits and assets. They enjoy voting right on all matters relating to the business of the company. They may earn dividend at a higher rate and have the risk of getting nothing. the importance of issuing ordinary shares is that no organisation for profit can exist without equity share capital. This is also known as risk capital.


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Advantages of equity shares:

Advantages of company: The advantages of issuing equity shares may be summarized as below:


I. Long-tern and Permanent Capital: It is a good source of long-term finance. A company is not required to pay-back the equity capital during its life-time and so, it is a permanent sources of capital.

II. No Fixed Burden: Unlike preference shares, equity shares suppose no fixed burden on the company’s resources, because the dividend on these shares are subject to availability of profits and the intention of the board of directors. They may not get the dividend even when company has profits. Thus they provide a cushion of safety against unfavorable development

III. Credit worthiness: Issuance of equity share capital creates no change on the assets of the company. A company can raise further finance on the security of its fixed assets.

IV. Risk Capital: Equity capital is said to be the risk capital. A company can trade on equity in bad periods on the risk of equity capital.


V. Dividend Policy: A company may follow an elastic and rational dividend policy and may create huge reserves for its developmental programmes.

Advantages to Investors: Investors or equity shareholders may enjoy the following advantages:

I. More Income: Equity shareholders are the residual claimant of the profits after meeting all the fixed commitments. The company may add to the profits by trading on equity. Thus equity capital may get dividend at high in boom period.

II. Right to Participate in the Control and Management: Equity shareholders have voting rights and elect competent persons as directors to control and manage the affairs of the company.


III. Capital profits: The market value of equity shares fluctuates directly with the profits of the company and their real value based on the net worth of the assets of the company. an appreciation in the net worth of the company’s assets will increase the market value of equity shares. It brings capital appreciation in their investments.

IV. An Attraction of Persons having Limited Income: Equity shares are mostly of lower denomination and persons of limited recourses can purchase these shares.

V. Other Advantages: It appeals most to the speculators. Their prices in security market are more fluctuating.

Disadvantages of equity shares:

Disadvantages to company: Equity shares have the following disadvantages to the company:

I. Dilution in control: Each sale of equity shares dilutes the voting power of the existing equity shareholders and extends the voting or controlling power to the new shareholders. Equity shares are transferable and may bring about centralization of power in few hands. Certain groups of equity shareholders may manipulate control and management of company by controlling the majority holdings which may be detrimental to the interest of the company.

II. Trading on equity not possible: If equity shares alone are issued, the company cannot trade on equity.

III. Over-capitalization: Excessive issue of equity shares may result in over-capitalization. Dividend per share is low in that condition which adversely affects the psychology of the investors. It is difficult to cure.

IV. No flexibility in capital structure: Equity shares cannot be paid back during the lifetime of the company. This characteristic creates inflexibility in capital structure of the company.

V. High cost: It costs more to finance with equity shares than with other securities as the selling costs and underwriting commission are paid at a higher rate on the issue of these shares.

VI. Speculation: Equity shares of good companies are subject to hectic speculation in the stock market. Their prices fluctuate frequently which are not in the interest of the company.

Disadvantages to investors: Equity shares have the following disadvantages to the investors:

I. Uncertain and Irregular Income: The dividend on equity shares is subject to availability of profits and intention of the Board of Directors and hence the income is quite irregular and uncertain. They may get no dividend even three are sufficient profits.

II. Capital loss During Depression Period: During recession or depression periods, the profits of the company come down and consequently the rate of dividend also comes down. Due to low rate of dividend and certain other factors the market value of equity shares goes down resulting in a capital loss to the investors.

III. Loss on Liquidation: In case, the company goes into liquidation, equity shareholders are the worst suffers. They are paid in the last only if any surplus is available after every other claim including the claim of preference shareholders is settled. It is evident from the advantages and disadvantages of equity share capital discussed above that the issue of equity share capital is a must for a company, yet it should not solely depend on it. In order to make its capital structure flexible, it should raise funds from other sources also.

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