EQUITY SHARES

 Equity shares or shares of common stock of a company are financial claims issued by the firm,
which confer ownership rights on the investors who are known as shareholders.
 All shareholders are part owners of the company that has issued the shares, and their stake in the
firm is equal to the fraction of the total share capital of the firm to which they have subscribed.
 In general, all companies will have equity shareholders, for common stock represents the
fundamental ownership interest in a corporation.
 Thus, a company must have at least one shareholder. Shareholders will periodically receive cash
payments from the firm called dividends.
 In addition, they are exposed to profits and losses when they seek to dispose of their shares at a
subsequent point in time.
 These profits/losses are referred to as capital gains and losses.

Stake in the firm = Total share Disposal of shares – share of

Investors-Owner ship Rights
capital subscribed by them profits and losses
EQUITY SHARES

 Equity shares represent a claim on the residual profits after all the creditors of the company have
been paid.
 That is, a shareholder cannot demand a dividend as a matter of right.
 The creditors of a firm, including those who have extended loans to it, obviously enjoy priority from
the standpoint of payments, and are therefore ranked higher in the pecking order.
 Equity shares have no maturity date. Thus, they continue to be in existence as long as the firm itself
continues to be in existence.
 Shareholders have voting rights and have a say in the election of the board of directors.
 If the firm were to declare bankruptcy, then the shareholders would be entitled to the residual
value of the assets after the claims of all the other creditors have been settled.
 Thus, once again, the creditors enjoy primacy as compared to the shareholders.

What are residual Who is priority? Creditors doesn’t have

profits? Creditors or Owners? rights in Election, profits
EQUITY SHARES

 The major difference between the shareholders of a company, as opposed to a sole proprietor or
the partners in a partnership, is that they have limited liability.
 That is, no matter how serious the financial difficulties facing a company may be, neither it nor its
creditors can make financial demands on the common shareholders.
 Thus, the maximum loss that a shareholder may sustain is limited to his investment in the business.
 Hence, the lowest possible share price is zero.

Common shareholders are not

Limited Liability
demanded by creditors
DEBT SECURITIES

 A debt instrument is a financial claim issued by a borrower to a lender of funds.

 Unlike equity shareholders, investors in debt securities are not conferred with ownership rights.

 These securities are merely IOUs (an acronym for “I Owe You”), which represent a promise to pay
interest on the principal amount either at periodic intervals or at maturity, and to repay the
principal itself at a prespecified maturity date.

Promise to pay interest

Issued by Borrower Ownership?
at intervals or at maturity
DEBT SECURITIES

 Most debt instruments have a finite lifespan, that is, a stated maturity date, and hence differ from
equity shares in this respect.
 Also, the interest payments that are promised to the lenders at the outset represent contractual
obligations on the part of the borrower.
 This means that the borrower is required to meet these obligations irrespective of the
performance of the firm in a given financial year.
 Quite obviously, it is also the case that in the event of an exceptional performance such as profits,
the borrowing entity does not have to pay any more to the debt holders than what was promised
at the outset.
 It is for this reason that debt securities are referred to as fixed income securities.

Borrowers obligation to repay Why fixed income?

Life Span – Maturity date
irrespective of performance (Either profit or Loss)
DEBT SECURITIES

 The interest claims of debt holders have to be settled before any residual profits can be distributed by way of
dividends to the shareholders.
 Also, in the event of bankruptcy or liquidation, the proceeds from the sale of assets of the firm must be used first
to settle all outstanding interest and principal.
 Only the residual amount, if any, can be distributed among the shareholders.

Either in residual profits or

High priority
bankruptcy liquidation
DEBT SECURITIES

 Debt instruments can be secured or unsecured.

 In the case of secured debt, the terms of the contract will specify the assets of the firm that have been pledged as
security or collateral.
 In the event of the failure of the company, the security holders have a right over these assets.
 In the case of unsecured debt securities, the investors can only hope that the issuer will have the earnings and
liquidity to redeem the promise made at the outset.
 In the United States, secured corporate debt securities are known as bonds, while unsecured debt securities
issued by corporations are termed as debentures.
 In certain countries the terms bonds and debentures are used for both categories of debt securities.
 Also, the world over, government debt securities are known as bonds.

Secured debt securities-Bonds

Unsecured Debt – Only the terms
Secured DEBT - collateral Unsecured debt security-
laid while issuing
Debentures
DEBT SECURITIES:

 Debt instruments can be either negotiable or nonnegotiable.

 Negotiable securities are instruments which can be endorsed from one party to another, and hence can be
bought and sold easily in the financial markets.
 A nonnegotiable instrument is one which cannot be transferred. Equity shares are obviously negotiable securities.
 While many debt securities are negotiable, certain loan-related transactions, such as loans made by commercial
banks to business firms and savings bank accounts of individuals, are examples of assets that are not negotiable.

Non negotiable – loans by banks

Negotiable and Non Negotiable
Equity shares are negotiable to firms and savings account of
debt securities
an individual
DEBT SECURITIES:

 Debt securities are referred to by a variety of names such as bills, notes, bonds, debentures, etc.
 US Treasury securities are fully backed by the federal government, and consequently have no credit risk associated
with them.
 The term credit risk refers to the risk that the issuer may default or fail to honor their commitment.
 Thus, the interest rate on Treasury securities is used as a benchmark for setting the rates of return on other,
more risky securities.
 The US Treasury issues three categories of marketable debt instruments – T-bills, T-notes, and T-bonds.
 T-bills are discount securities also known as zero-coupon securities.
 That is, they are sold at a discount from their face value, and do not pay any interest.
 They have a maturity at the time of issue that is less than or equal to one year.

Names such as bills Government bonds –

What is credit risk?
bonds No credit risk
PREFERRED SHARES:

 Preferred stocks are a hybrid of debt and equity.

 They are similar to debt in the sense that holders of such securities are usually promised a fixed rate of return.

 However, such dividends are payable from the post-tax profits of the firm, as in the case of equity shares.

 On the other hand, interest payments to bondholders are made from pre-tax profits, and therefore constitute a

deductible expense for tax purposes.

Hybrid characteristics of both debt

Promised fixed rate of return
and equity
PREFERRED SHARES:

 This implies that any unpaid dividends in a financial year must be carried forward, and the accumulated dividends

must first be paid before the company can contemplate the payment of dividends to equity shareholders.

Unpaid dividends – Carry

Priority than equity shareholders
forwarded
 PREFERRED SHARES:

 Preferred shareholders have restricted voting rights.

 That is, they usually do not enjoy the right to vote unless the payment of dividends due to them is in arrears.
 In the event of liquidation of the firm, the preferred shareholders will have to be paid off before the claims of the
equity holders can be entertained.
 Thus, the order of priority of the stakeholders of the firm from the standpoint of payments is
 bondholders first,
 followed by preferred shareholders,
 and then equity shareholders.
 Within the category of bondholders, secured debt holders get priority over unsecured debt holders.
 The term preferred arises because such shareholders are given preference over equity shareholders, and not because
the shareholders prefer such instruments.
In bonds – Priority is given to
Sequence of stakeholders- 1,2,3
secured bond holders
MONEY AND CAPITAL MARKETS

 Consider the case of a government. Revenue comes primarily in the form of taxes and is lumpy in nature.
However, expenses are incurred on a daily basis.
 Consequently, if the government were to have a budget surplus, which is rare in practice, for most governments
have budget deficits, during most of the year there will be a deficit.
 Consequently, governments need to constantly borrow to meet the shortfalls.
 Similarly, a business may have a substantial profit in a financial year but may have a cash deficit on most days.
 Thus, it would need to borrow periodically to bridge the shortfall.

To meet the
Governments Surplus budget is shortfalls –
Example - Income comes from But expenses are rare- most of the Governments
Government ?? daily?? governments are constantly borrow
deficit from money
markets
MONEY AND CAPITALMARKETS

 A capital market, on the other hand, performs a very different economic function.
 The purpose of a capital market is to channelize funds from people who wish to save to those who wish to make
long-term investments in productive assets in an effort to earn income.
 Thus, when a government or a municipality needs to finance developmental activities that are long-term in nature,
such as building a metro railway or putting up an oil refinery, or when a business wants to expand or diversify, it
will approach the capital market for the required funds.

The purpose is – people who Governments – long term

Other hand- capital market
wish to save – long term investments – metro rail – oil
differs
investment refinery – Maharatna PSUs
EQUITY SHARES: AUTHORIZED CAPITAL & ISSUED CAPITAL

 At the outset, when a firm is incorporated a stated number of shares will be authorized for issue by the
promoters.
 The value of such shares is referred to as the authorized capital of the firm; however, the entire authorized capital
need not be raised immediately.
 In practice, often a portion of what has been authorized is held for issue at a later date, if and when the firm
should require additional capital.
 Thus, what is actually issued is less than or equal to what is authorized and the amount that is actually raised is
referred to as the issued capital.
Out of authorized
Intially all number of
shares some are kept Such amount raised
shares are authorized Such value is called as and issued later when by this is called issued
and offered by authorized capital they require capital
promoters
additional capital
EQUITY SHARES:

 In the event of a company buying back shares from the public, however, the outstanding capital will decline and
consequently will be less than what was issued.
 Shareholders are entitled to share the profits made by the firm, as they represent the owners of the venture.
 A firm will typically pay out a percentage of the profits earned by it during the financial year, in the form of cash to
its shareholders.
 These cash payouts that shareholders receive from the firm are referred to as dividends.

Share holders are entitled to Firm pays percentage of profit

share the profits and in the form of cash yearly
ownership called as dividends
EQUITY SHARES: RETAINED EARNINGS

 In practice, the entire profits earned by a firm will usually not be distributed to the shareholders.
 Most companies will choose to retain a part of what they have earned to meet future requirements of cash on
account of activities such as expansion and diversification.
 The profits that are retained or reinvested in the firm are called retained earnings.
 The earnings that are retained will manifest themselves as an increase in the Reserves and Surplus account and
will show up on the liabilities side of the balance sheet of the firm.
 Retained earnings can be a major source of capital for a corporation.

Not the entire profit is Some profits retained are

distributed to shareholders called retained earnings
EQUITY SAHRES: RESIDUAL CLAIMANTS

 Shareholders are termed as residual claimants, and this categorization is valid in two respects.
 Every firm will have creditors to whom it owes money on a priority basis.
 For instance, it is a common practice to raise borrowed capital from investors in the form of what are known as
bonds or debentures.
 Creditors always enjoy priority over the owners of the firm when it comes to receiving payments.
 Thus, a firm may declare a dividend only after all payments due to its creditors have been made.
 Being a residual claimant, a shareholder cannot demand a dividend as a matter of right.
 It is up to the board of directors of a firm to take decisions pertaining to dividends.
 Shareholders, of course, indirectly influence the dividend policy of the firm, because they have the power to elect
the board of directors.
Share holders indirectly
Board of directors – influence the board
Share holders are Share holder cannot takes decision on how about dividend policy
residual claimants demand the dividend much dividend by the power they got
to elect them
PAR VALUE:

 Common stock usually has a par value also known as the face value or the stated value.
 The par value has no significance in practice, and in countries like the United States it can be fixed at a low and
arbitrary level.
 Many companies in the United States choose to issue stocks with very low par values because, as per the
regulations of certain states, the cost of incorporating a firm is based on the par value of the shares being
registered.
 Hence such fees can be minimized by assigning low par values.

Par value or face value is

nominal value that is given
to share by the company
PAR VALUE:

 Assume a firm is authorized to issue 250,000 shares with a par value of $10 each, and that it has chosen to issue
150,000 shares.
 Thus, the authorized capital is $2.50 million while the issued capital is $1.50 million.
 At times, the company may ask the shareholders to pay up a fraction at the outset and call for the balance later.
 In such situations, the paid-up capital, which is the amount paid per share multiplied by the number of shares
issued, will be less than the issued capital.
 If we assume that the shareholders have been asked to pay $8 per share, the paid-up capital is $1.20 million.
 If the firm were to subsequently experience financial difficulties, the creditors can demand that the shareholders
pay up the difference between the issued capital and the paid-up capital, which is $300,000 in this case.

Firm authorized 2,50,000 But chosen to issue only Authorized capital is 2.50M$
shares with a par value 10$ 1,50,000 shares where as issued capital is
1.50 M$
PAR VALUE & SHARE PREMIUM

 The issue price of a share need not be equal to its par value and will often be in excess of its par value.
 This is true for companies that are already established at the time of issue.
 The excess of the issue price over the par value is referred to as the share premium.
 For instance, assume that Alpha Corporation is issuing 100,000 shares with a par value of $5 at a price of $12.50
per share.
 If the issue is successful, the company will raise $1,250,000 from the market.
 In the balance sheet, $500,000 would be reported as share capital and $750,000 would be reported as the share
premium.
Alpha is issuing 5,00,000$ as share And remaninig
1Lakh sahres with Company will raise capital 7.50,000$ as share
In the balance
face value at 5$ 12,50,000$ premium
sheet it is noted as (1LK shares * 5$
and market price
of 12.50$ face value) (1Lk shares * 7.5$)
SHARE PREMIUM EXAMPLE:

 A company issues 100 shares with a nominal value of £1 per share.

 If the company sells the shares for only £1 each, it will receive a total of £100 in share capital. In this scenario,
there is no share premium.
 However, if the company sells the shares at a premium of £10 each, it will receive a total of £1,000 equity.
 In this scenario, the share premium is £9 (£10 market value minus £1 nominal value), or £900 in total (£1,000
minus £100). The other £100 is share capital.
VOTING RIGHTS:

 At times equity shares are divided into two or more classes with differential voting rights.
 One or more categories may have subordinated voting rights, and at times a category may be issued with no
voting rights.
 The purpose of such an exercise is to vest the voting powers with a minority of shareholders who can
consequently control the company with less than a 50% equity stake.
 A group of shareholders can exert considerable influence over the affairs of their company if they satisfy one of
these criteria:
 They own more than 50% of the voting shares.
 When they have one or more representatives on the board of directors.
 When they themselves are directors of the company.

A group of share holders can

Differential voting rights exert influence if they comes
under one of the above
VOTING RIGHTS:

 In practice, minority shareholders have very little say in the affairs of their company, despite the fact that they do
enjoy voting rights.
 This is particularly true when the company is controlled by a majority shareholder.

Minority share Participation company

holders? affairs high or less
STATUTORY VERSUS CUMULATIVE VOTING

 Every share of stock held by an investor corresponds to one vote for each director position that is up for voting;
however, the votes may be apportioned in two different ways.
 Assume that a shareholder has 1,000 shares and that there are four vacancies on the board.
 If statutory voting were to be applicable, the shareholder can cast a total of 4,000 votes in all; however, not more
than 1,000 votes can be cast in favor of any one candidate.

Two types of voting Share holder has 1000 shares

& four vacancies on the board
Statutory – can cast 4000 votes in all but not more than 1000 for
one candidate
STATUTORY VERSUS CUMULATIVE VOTING

 On the other hand, if cumulative voting were to be applicable, then the votes could be apportioned in any way
that the shareholder chooses.
 In this case too, a total of 4,000 votes can be cast.
 One shareholder may decide to cast 3,000 votes in favor of one candidate and 1,000 in favor of a second, without
giving any votes to the remaining candidates.
 Alternatively, another shareholder in a similar situation may cast 1,000 votes in favor of each of four candidates.
 Cumulative voting is designed to give minority shareholders the opportunity to elect at least one candidate of
their choosing, for it gives them the power to concentrate the votes on a candidate.

Cumulative – 3000 votes to one candidate and 1000 to the other

(without voting the remaining candidates)
PROXIES:

 In order to enjoy the right to vote, an investor must be a shareholder of record.

 The registrar of a firm will be maintaining a record of its current shareholders.
 Only those listed on the corporation’s register of shareholders as of a date known as the record date are eligible
shareholders, from the standpoint of being eligible to cast a vote.
 The record date is usually a few days prior to the date of the meeting at which the actual voting will take place.

Registrar maintains a record Record date – usually few days prior to the AGM Investor must be in the record
PROXIES:

 Therefore, in practice, it is conceivable that a person who happens to be a shareholder of record, by virtue of
their name appearing in the register on the record date, may have sold their shares prior to the date of the
meeting.
 In such cases the new owner who has acquired the shares cannot in principle vote, as their name will not be
reflected in the register.
 To get over this problem, the seller(s) of the shares can give a proxy to the buyer(s).

The new owner wont be able to participate – no reflection of his

Investors sold his shares prior to the meeting In this case sellers of share give proxy
name in the register
PROXIES

 It is not realistic to expect a large percentage of the shareholders of large companies to attend the annual
meetings in order to be physically present to cast their votes.
 Thus, in practice, companies choose to send a proxy statement to absentee shareholders along with a ballot, prior
to the scheduled date of the meeting.
 The shareholders are expected to mark their preferences and return the ballot prior to the date of the meeting.
 A typical proxy statement will include information on the individuals seeking appointment or reappointment as
directors, and details of any resolutions for which the opinions of the shareholders are being sought, which is
consequently the raison d’être for the vote.

Companies send this absentees a ballot prior to the meeting

PROXIES:

 Once the ballots are received from the absentee shareholders, they will be collated, and a person appointed by
the firm will cast the votes as directed by the shareholders who have submitted the ballots.
 In practice there is a critical reason why companies require shareholders to attend meetings or to send proxies if
they are unable to be physically present.
 This is because a quorum is required before any business can be transacted.
 That is, a minimum number of shares must be represented at the meeting, either by the holders in person or in
the form of proxies.

Either physically or through ballot should participate – quorum

Companies send this absentees a ballot prior to the meeting
the minimum number of members of an assembly or society that must be present at any of its meetings to make the
proceedings of that meeting valid.
DIVIDENDS

 As explained earlier, shareholders are residual claimants.

 Consequently, they cannot demand dividends from the firm; that is, dividends, unlike interest payments to
creditors, are not a contractual obligation.
 That is, the payment of dividends is not mandatory, and the decision to pay or not to pay is entirely at the
discretion of the board of directors of the company.
 Companies usually declare a dividend when they announce their results for a period.
 In the United States, since results are typically declared on a quarterly basis, dividends are also announced every
quarter.
 In the United Kingdom most companies pay their annual dividends in two stages.

Companies declare US – Every quarter

Share holder dividend once they
Residual Claimants? cannot demand the UK – Annual
announce the
dividend results for a period Dividend
DIVIDENDS:

 A dividend declaration is a statement of considerable importance.

 It is an affirmation by the company that its affairs are on track, and that it has adequate resources to reinvest in its
operations as well as to reward its shareholders.

Which says all the Reward

Dividend shareholders?
affairs are on
declaration
track Why?
DIVIDENDS:

 In the context of a dividend payment, there are dates that are important.
 The first is what is termed as the declaration date. It is the date on which the decision to pay a dividend is declared
by the directors of the company, and the amount of the dividend is announced.
 The dividend announcement will mention a second date called the record date.
 The significance of this date is the same as we have seen earlier for voting.
 That is, only those shareholders whose names appear as of the record date on the register of shareholders will be
eligible to receive the forthcoming dividend.

1) Declaration Date 2) Record Date

DIVIDEND YIELD:

 The annual dividend yield is defined as the annual dividend amount divided by the current share price, expressed
in percentage terms.
DIVIDEND YIELD:

 A company that has reported a dividend of $2.50 per quarter over the past financial year. Assume that the current
market price of the shares is $80.
 The dividend yield is:
DIVIDEND YIELD: