This article will give you a good knowledge and understanding on what is equity stock in the financial market, and also rights of the equity holders.
In the financial industry especially in corporate finance, you’ll hear stock and also equity as the two terms comes hand in hand.
But on this article, is all about equity stock and not stock or maybe equity on it’s own.
What is Equity Stock
Equity Stock Definition: This is the most important source of corporate finance.
Is usually the first instrument to be issued by a firm and continues to play a dominant role throughout the life of a firm.
Sometimes can afford not to issue other forms of security, but common stock is indispensable in the life of a firm.
The holders of common stock are the owners of the firm and so carry most of the risk in the business.
If the operation of the Firm involves substantial loss that might lead to liquidation, the holders of common stock, will bear the brunt of the business failure.
This is because their claim is subordinated to that of other claimants in the firm.
However, this position of risk which the occupy might result to their benefit if the business is prosperous.
In that case while other claimants will receive a stipulated percentage of their investment, the equity holders will have residual claims to the earnings of the company.
Common stock will generally appeal to risk neutral and risk loving investors.
While bonds, debenture and preferred stock will appeal to the risk-averse Investor.
Investors who invest in equity stock want to participate in the prosperity of the firm and have a say in the running of the organisation common stock holders.
They bear the risk of the business because they are residual claimant against the assets of the business.
As residual claimants, it means that what they eventually receive is much less than what the firm has earned during the period.
Rights of Equity Stock Holders
Having understood what is equity stock, next is the rights of the equity holders in the corporate finance.
The rights of equity holders can be classified into two, collective rights and specific right.
The specific rights may be further classified into attractive rights and protective right.
Collective Rights in Equity stock
These are right enabling the equity holders to establish major policies of the firm, such as;
1. Selection of the board of directors.
The holders of common stock periodically appoint members of the board of directors who will supervise the activities of the company.
2. Amend the charter establishing the organisation.
This involves a lot of legal requirements which must satisfy the relevant authorities before such approval will be granted.
3. Authorise the sale of fixed assets.
There are some asset which the management could dispose of but some strategic assets of the Firm cannot be disposed of without the approval of the equity holders.
4. Amendment of bye-laws.
Most of these bye-laws are embodied in the articles of association.
5. Enter into mergers or buy subsidiaries.
6. Change the authorised capital. Just as the amending the charter, this process is very rigorous and time consuming.
It is because of this problem that many promoters prefer to blow up the amount of authorised capital that they will issue.
This is necessary so as to avoid this problem in the event of expansion.
7. Issue other Securities.
Sepecific Rights
In the equity stock, the specific right can be further be classified into attractive and protective right.
Attractive Rights
The holders of equity stock has already pointed out, bear most of the risk in the organisation.
Since the position of equity holders is a risky one, these rights have been designed to attract potential equity investors.
Some of the attractive rights in the equity stock includes;
1. Right to share in the dividend; This is the right that attract investors to purchase equity stock.
Rational investors do not purchase share because of the beauty of the firm, but because of what they expect to receive from it in form of dividend.
This they determined by looking at the historical records of the firm.
It must be emphasized that the stock holder had no legal right to the firm’s stream of net income.
The common Stock holders have a right to share dividends but the board of directors reserve the right to declare or not to declare dividend.
2. Rights to have a claim against the assets: Although this is an attractive right, this is one of the right that is least desired by the equity holders.
Equity investors do not by their shares so that they will enjoy this right.
Investors purchase stocks so that they will benefit from a stream of cash flows (dividends) as a going concern.
We believe that investors will be unwilling to put in even one Naira of their money in any firm which they know is at the break of liquidation.
3. Rights to participate in management and control: Equity holders have a right to participate in the management and control of their organisation.
Unfortunately, this is one of those rights which they cannot exercise directly but must exercise is indirectly.
This is a right which the exercise through the board of directors.
Once the member of the board is appointed, they become a repository of the power of the share holders.
As trustees of the shareholders they must discharge their responsibility to the best of their ability and in good faith.
In the event of the business running into difficulties in view of decision taken by the members of the board.
The shareholders cannot claim against the member of the board in so far as the act was in good faith.
But if through dishonesty and negligence the business encounters a problem, then the members of the board are answerable to the shareholders, who might seek redress in the court.
Protective Rights
The second is the the protective rights in the equity stock, and these are right that are designed to protect the interests of the equity holders.
The risk inherent in equity holding is enormous and some rights have been designed to protect the interest of the Stockholders.
1. Right to have evidence of ownership: Shareholders have the right not only to have their names registered in the books of the company but to have evidence of ownership which they keep in their custody.
2. Right to transfer the stock: This includes right-to-sell, pledge it as collateral.
The right to participate in management, profit and even share in assets may be attractive but this to right makes the concept of equity investment worthwhile.
Since the risk in equity investment is enormous, prospective investors will want some guarantees that in the event of difficulties they can pull out of the company on time and minimise their losses.
It is this very right that guarantees it. Many investors look on equity holding as a form of short term investment.
3. Right to prevent unlawful acts: Unlawful acts include act that are ultra vires, illegal act, act designed to foster the interests of a particular group.
All these acts may prove inimical to the interests of the stock holders.
A shareholder who perceives that the company is about to commit an illegal act, can stop it been seeking a court injunction.
On the other hand, if the act have been committed, they have a right to seek legal remedies in court.
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That’s it on equity stock and the rights of the equity holders in the corporate finance or the financial market.