Shares represent equal portions into which the capital of a company is divided, each shareholder being entitled to a portion of the company’s profit corresponding to the number of shares he has in his name.
A company can issue two types of shares namely equity shares and preference shares. Equity shares or the common stock is regarded as the corner stone of the financial structure. Both for legal and economic reasons, a company organised for profit can’t exist without equity shares in so far as they do not carry with them any fixed commitment charges. If a company is earning large profits, the shareholders get a higher amount as dividend and if somehow the profits of the company come down then in that case the equity shareholders will get lesser amount for their investment. The fact that company does not have to pay any fixed return on the equity shares is one of the main advantages of using this method of raising finance. It is in fact the first type of security to be issued by the corporations and the last to retire in the event of liquidation, so it occupies primary and residual position respectively in the two situations. As has been said earlier, one must note that the earnings of the equity shareholders vary according to the earnings of the company. So it is said that any change in the business brings corresponding changes in the fortunes of the equity shareholders. Because of this position equity capital is said to be the venture capital or risk capital of the company and it is provided by the ordinary or equity shareholders.
The main feature of the common stock is that it provides a way of raising cash for the company with no fixed commitment charge attached to it.
From the investor point of view, equity share-holding gives the shareholder an opportunity to share in the profits when declared as dividends, an opportunity to make money on appreciation in the value of shares and opportunity to vote for the directors of the company.
However, equity shares, as a method of providing funds, are not free from certain problems which can be stated as :
(i) The issue of large proportion of equity shares results in the dilution of control by the clique of the equity holders.
(ii) Use of more equity share capital deprives right from trading on equity which results in losing opportunity of using cheap borrowed capital.
(iii) Excessive use of equity may result in overcapitalisation.
(iv) It is having an attraction only for those who can not take risk.