Equity capital represents ownership capital. Equity shareholders collectively own the company. They bear the risk and enjoy the reward of ownership. Of all the forms of securities, equity shares appear to be the most attractive but always have a risk. While fixed income investment avenues may be more important to most of the investors, equity shares seem to capture their interest the most. The potential rewards and penalties associated with equity shares make them an interesting, even exciting proposition. No wonder equity investment is a favorite topic of conversation in parties and get-togethers.
The amount of capital that a company can issue as per its memorandum represents the authorized capital. The amount offered by the company to the investors is called the issued capital. That part of the issued capital that has been subscribed to by the investors is called the paid-up capital. Typically the issued, subscribed and paid up capital are the same.
The par value is stated in the memorandum and written on the share scrip. The par value of equity shares is generally Rs 10(the most popular denomination) or Rs 100.Infrequenlty one comes across par values Re 1, Rs 5, Rs 50 and Rs 1,000. The issue price is the price at which the equity share is issued. When the issue price exceeds the par value, the difference is referred to as the share premium. Note that the issue price cannot be, ordinarily lower than the par value.
The book value of an equity share is equal to:
Paid up equity capital + Reserves and surplus / Number of outstanding equity shares
Quite naturally, the book value of an equity share tends to increase as the ratio of reserves and surplus to the paid-up equity capital increases. The market value of an equity share is the price to which it is traded in the market. The prices can be easily established for a company that is listed on the stock market and actively traded. For a company that is listed on the stock market but traded very infrequently, it is difficult to obtain a reliable market quotation. For a company that is not listed on the stock market one can merely conjecture as to what its market price would be if it were traded.
Rights of Equity Shareholders:
As owners of the company equity shareholders enjoy the following rights:
Equity shareholders have a residual claim to the income of the firm. This means that the profit after tax less preference dividend belongs to equity shareholders. However, the Board of director has the prerogative to decide how it should be spilt between dividends and retained earnings. Dividends provide current income to equity shareholders and retained earnings tend to increase the intrinsic value of equity shares. Note that equity dividends are presently tax exempt up to a certain limit.
Equity shareholders elect the board of Directors have the right it vote on every resolution placed before the company. The Board of directors, in turn appoints the top management of the firm. Hence equity shareholders, in theory exercise an indirect control the operations of the firm. In practice, however equity shareholders scattered, ill-organized passive and indifferent as they often are fail to exercise their collective power effectively.
Equity shareholders enjoy the pre-emptive right enables them to maintain their proportional ownership by purchasing the additional equity shares issued by the firm. The law requires companies to give existing equity shareholders the first opportunity to purchase on a pro rata basis, additional issue of equity capital. For example, if you own 1,000 equity shares in a company that has 1,000,000 outstanding shares, you are entitled to subscribe to 200 shares if the company proposes to issues 200,000 additional shares. The equity shareholders of the company may, however, forfeit this right partially or totally, to enable the company to make a public issue.
As in case of income, equity shareholders have a residual claim over the assets of the company in the event of liquidation. Claims of all others – debenture holders, secured lenders, unsecured lenders preferred shareholders and other creditors are prior to the claim of equity shareholders.