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What is Equity Shares ? | Meaning, Characteristics, Advantages & Disadvantages

Equity Shares

Contents :
  • Meaning of Equity Shares.
  • Characteristics of Equity Shares.
  • Advantages of Equity Shares.
  • Disadvantages of Equity Shares.

What is Equity Shares ? 


The equity shares may be regarded as the foundation of the financial structure of a company. They occupy a primary position. They represent the ownership capital of a company. The equity shareholders collectively own the company and enjoy all rewards and risks associated with such ownership. They do not have any preferential rights regarding either the payment of dividend or the repayment of capital at the time of company's liquidation.

Meaning of Equity Shares 


The equity shares are those which are not preference shares. In other words, shares which do not enjoy any preferential right in the matter of payment of dividend or repayment of capital are known as preference shares. Equity shareholders have overall rights of sharing dividends, voting rights in the General Meeting of the company. Equity shareholders are given dividend after the payment of claims of preferential shareholders and debenture holders. Equity shareholders get dividend out of residual net profits at a rate recommended by Board of Directors and eventually approved by the General Meeting of shareholders.

Characteristics of Equity Shares 


Equity Shares also known as ordinary shares, which means, other than preference shares. Equity shareholders are the real owners of the company. They have a control over the management of the company. The features of equity shares are as follows:

1) Residual Claim on Income :
Equity shareholders have a residual claim on the income of the company. They have the claim on income only after the payment of preference dividend. If the profit shares insufficient to pay the dividends, the directors may skip the equity dividend. Even in the case of sufficient profits, the shareholders cannot legally force the directors to pay dividend. Board of Directors have the right to decide that how much part of the profit is to be distributed as dividends and how much is to be retained in the business.

2) Residual Claim on Assets :
The claim of the equity shareholders on the assets of the company is also residual. In case of liquidation, the preference shareholders will be repaid first after paying debts and in the last, the equity shareholders are to be paid off. It may happen that they even do not get anything in case of liquidation.

3) Limited Liability :
The liability of the equity shareholders is limited to the amount of shares they have purchased. In case of liquidation, they have the liability to pay if the shares are partly paid-up. If the shares are fully paid-up, they are not liable to pay anything. This provides them a facility to enjoy ownership without unlimited liability.

4) Pre-Emptive Rights :
Equity shareholders are provided with pre-emptive rights. This right protects their interest in the company. Pre-emptive right means the right to purchase new shares issued by the company. As per Section 81 of the Companies Act, 1956, whenever a company proposes to increase its capital by issue of further shares, it must offer such shares to holders of existing equity shares in proportion of existing shareholdings. Such shares are called as right shares and such right of shareholders is known as pre-emptive right. It protects shareholders from dilution of their financial interest in the company.
The existing shareholders are given the right to maintain their proportional ownership by purchasing additional equity shares issued by the company. When new issues are made, the existing shareholders are to be given a preferential right to buy the new issue in proportion to their holding. This is known as rights shares. These shares are issued to the existing shareholders at a price lower than the price at which it is issued to the public.

5) Maturity of the Shares :
Equity shares have permanent nature of capital, which has no maturity period. It cannot be redeemed during the lifetime of the company.

6) Right to Control :
The equity shareholders have full right to control the company as owners of the company. They enjoy voting rights in the meetings of the company. As such, the company is run by Board of Directors. But they are elected by the equity shareholders. Hence, equity shareholders exercise an indirect control over the working of the company.

7) Rights against Ultra Vires acts of the Company :
The equity shareholders are exposed to the risks mentioned in the Memorandum and Articles of Association of the company. Any act done by the company, which is not mentioned in the Memorandum and Articles, are ultra vires. Therefore, the acts of ultra vires are a breach of agreement between the company and the shareholders. The equity shareholders have the right to take legal steps against the company to prevent it from engaging in such actions.

8) Right to have knowledge of Corporate Affairs :
The equity shareholders have the right to know about the affairs of the company at least once a year. The shareholders can present all their grievances at the annual general meeting of the company.

9) Right to Transfer Shares :
The shareholders have the right to transfer equity shares to anyone they like. If dissatisfied, they can convert their shares into cash in the stock-market.

Advantages of Equity Shares 


As far as the company is concerned, equity shares are considered superior to any other form of capital. Equity shares are the most common and universally used shares to mobilize finance for the company. It consists of the following advantages.

1) Permanent Sources of Finance :
Equity share capital is belonging to long-term permanent nature of sources of finance hence; it can be used for long-term or fixed capital requirement of the business concern.

2) Voting Rights :
Equity shareholders are the real owners of the company who have voting rights. This type of advantage is available only to the equity shareholders.

3) No Fixed Dividend :
Equity shares do not create any obligation to pay a fixed rate of dividend. If the company earns profit, equity shareholders are eligible for profit, they are eligible to get dividend otherwise, and they cannot claim any dividend from the company.

4) Less Cost of Capital :
Cost of capital is the major factor, which affects the value of the company. If the company wants to increase the value of the company, they have to use more share capital because, it consists of less cost of capital while compared to other sources of finance.

5) Retained Earnings :
When the company have more share capital, it will be suitable for retained earnings which are the less cost sources of finance while compared to other sources of finance.

6) Advantages to the investors :
From the investor's point of view, the equity shares offer the following advantages :
  • Most of the profit-making companies pay dividend regularly.
  • An investor can expect bonus-shares from high profit-making companies.
  • They get a right on a pro-data basis when the company issues new shares. It is issued to the existing shareholders at a price lower than the market price.
  • If a good share is picked up, the market value of investment will appreciate over a period of time.
  • An equity shareholder is one of the owners of the company.
  • Equity shares have liquidity and marketability as these are listed and quoted on stock exchanges.
  • Equity shares of listed companies can be pledged as security to raise loans from banks and other financial institutions.

7) Serve as a Base for Further Borrowings :
They serve as a base for further borrowings because greater the amount of equity capital, greater the scope for raising further debt.

Disadvantages of Equity Shares


It is true that the equity capital is a reliable source of finance to a company. But it suffers from certain disadvantages, they are as follows:

1) Irredeemable :
Equity, shares cannot be redeemed during the lifetime of the business concern. It is the most dangerous thing of over capitalization.

2) Obstacles in Management :
Equity shareholder can put obstacles in management by manipulation and organizing themselves. They have power to contrast any decision against the wealth of the shareholders.

3) Leads to Speculation :
Equity shares dealings in share market lead to secularism during prosperous periods.

4) Limited Income to Investor :
The Investors who desire to invest in safe securities with a fixed income have no attraction for equity shares.

5) No Trading on Equity :
When the company raises capital only with the help of equity, the company cannot take the advantage of trading on equity. If the company raises all its capital through equity shares, it will not get the benefit of trading on equity. So, the rate of dividend to the equity shareholders will be reduced.

6) Affects the Promoters :
Too much dependence on equity shareholders spreads the effective control over a large number of them. It adversely affects the promoters of the company, who lose the chance of retaining effective control over the affairs of the company.

7) Over capitalization :
Excessive use of equity shares for raising capital may result in over capitalization, which cannot be cured as they cannot be paid back until the liquidation of the company.

8) Disadvantages to the Investors :
Some of the disadvantages in investing funds in equity shares from the point of view of investors are :
  • The market values of equity shares are most stable. The frequent fluctuations in prices will lead to psychological stress for the investor.
  • Investing in equity shares is risky as the expectation of earning profits involves uncertainty.
  • The investor has to reside in a place where a stock exchange is located in order to end a broker and to deal with the shares at the right time and at the right price.
  • Over subscription of new issues of good companies reduces the hopes for an investor to get allotment of shares.

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