Equity refers to the ownership interest or residual claim in the assets of a firm after all the liabilities of the firm have been paid. While referring to a firm’s balance sheet, equity refers to the capital contributed by the owners (also known as shareholders) plus any retained earnings or losses.
A firm can issue various types of equity securities to raise capital. Different securities have different ownership claim on the company’s net asset.
Common shares are the most common type of equity securities issued by a company.
- If the firm is liquidated, the common shareholders will have the residual claim over the assets of the firm after all debt and preferred stock has been paid.
- Common shares provide voting rights to the shareholders which provide the shareholders the ability to participate in major corporate decisions such as election of directors, mergers and acquisitions, selection of auditors, etc.
- The company is not obligated to pay dividends to the common shareholders every year. It may choose to pay some or all of its net income as cash dividend to common shareholders.
- Shareholders may attend the annual general meeting in person and use their vote. If they are not able to attend, they can also vote by proxy (i.e., have someone else vote on their behalf).
Callable and Puttable Common Shares
The common shares may also be callable or puttable. A call option gives the issuer of the common shares the right, but not the obligation to call the shares back at a pre-specified call price which is set at the time the common shares are issued. These shares are also called redeemable common shares. The issuer will generally call the shares when the current market price is higher than the call price. In such a case, the issuer can buy back the shares at the call price and sell them in the market at the market price. Note that it’s a right of the company and the investors holding the shares are obligated to sell if the issuer decides to call back the shares. Calling the shares helps the companies in reducing their dividend payments.
A put option gives the investor the right but not the obligation to sell the common shares back to the issuer at a prespecified price set at the time the shares were issued. Investors will be interested in selling the shares back if the current market price is less than the put price. This helps the investors in lowering their loss potential. Put options are beneficial for issuers as they make their issue more attractive to investors.