Chapter 23 Equity, Debt and Money Market Instruments 795

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ity An e: it EquoiStia re s profits earned on those assets after other claims have been met. The equity bare of any ssbareholders are the owners of the business; they purchase shares, the money is used by the company

Market Instruments

to buy assets, the assets are _used to earn profits, which belong to the ordinary shareholders, After satisfying the rights preference shares, the equity shares shall be entitled to share in the remaining amount of distributable net profits or the company. The dividend on equity shares is not fixed and may vary from year to year dependi ng upon the amount of profits available. The rate of dividend is recommended by the board of directors of the company and declared by shareholders in the annual general meeting. Equity shareholders have a right to vote on every resolution placed in the meeting and the voting rights shall be in proportion to the paid-up capital. As a sOurCe Of loing-terM finance, ordinary shares carry a number of advantages and disadvantages for a company. Advantages (a) There are no fixed charges attached to ordinary shares. If a company generates enough earnings it will be able to pay a dividend but there is no legal obligation to pay dividends. (b) Ordinary shares carry no fixed maturity. (c) They provide a cushion against losses for creditors, thus the sale of ordinary shares rather than other securities increases the creditworthiness of the firm. (d) Ordinary shares can often be sold more easily than debentures. (e) Returns from the sale of ordinary shares in the form of capital gains are subject to capital gains tax rather than corporation tax. Nadva ntag es (a) The sale of ordinary shares extend voting rights or control to the additional shareholders who are brought into the company. (b) More ordinary shares give more people the right to share with the existing owners in the company profits. (c) The costs of underwriting and distributing new issues of ordinary shares are usually higher than those for underwriting and distributing preference shares or debentures. (d) If the firm has more equity or less debt than is called for in the optimum capital structure, the average cost of capital will be higher than necessary. (e) Dividends payable to ordinary shareholders are not deductible as an expense for the purpose of corporation tax but debenture interest is deductible.
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reference Shares

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eference shares is a hybrid security because it has features of both ordinary shares and bonds. eference shareholders have preferential rights in respect of assets and dividends. In the event O f W inding up the preference shareholders have a claim on available assets before the ordinary share holders. In addition, preference shareholders get their stated dividend before equity shareholders can receive any dividends. The dividends on preference shares are fixed and they must be declared before a legal obligation exists to pay them. The fixed nature of dividend is similar 1?! hat of interest on debentures and bonds. The declaration feature is similar to that of equity

olders dividends. As a hybrid security, the use of preference shares is favoured by that fall between those favouring the use of ordinary shares and those favouring

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