Term Paper for Graduate Students

Pros and cons of ordinary share

Course Business Law

Name Zhang Mohan

Number 2012265

Date 2013.12

Abstract

Ordinary share is the foundation of company's capital structure and a basic form of stock. In this paper, we discuss the definition of ordinary share first, then come to the rights and obligations of ordinary share. We focus on the pros and cons of ordinary share mainly from financing perspective and compare with the preference share at last. Above all,we give some advise to corporate financing.

1.The definition of ordinary share

According to the company law, ordinary share is a kind of stock to enjoy common rights in corporate management and the allocation of profit and property. It represents the residual claims of company earings and property after satisfying all claims of reimbursement requirements and preferred shareholders rights. Ordinary share is the foundation of company's capital structure and a basic form of stock. It’s also the largest circulation share, the most important stock, which is also called common stock. At present, traded on the Shanghai and Shenzhen Stock Exchange, are all common stocks.

2. The rights and obligations of ordinary shares.

2.1.The rights of ordinary shares

Ordinary share holders enjoy the following basic rights based on their proportion of shares:

(1)The voting rights to participate in company’s business.

Ordinary shareholders generally have the right to attend the general meeting of shareholders, voting, to elect and to be elected. Also they can indirectly participate in the company's business.

(2)The distribution rights of profit.

Ordinary shareholders have the right to get dividends from the company profit distribution. Ordinary share dividend is not fixed, assigned by the company's profit situation and its policy decisions. Common shareholders shall have the right to enjoy the dividend distribution must after preferred shareholders obtain fixed dividend.

(3)Stock options

If the company needs to expand the sale of common stock shares, ordinary shareholders shall have the right to buy a certain number of newly issued stocks at a specific price which is less than the market price according to their existing stake, to maintain their original proportion of the ownership of enterprises.

(4)The allocation rights of remaining assets

when the company's bankruptcy or liquidation, if the company's assets are still remaining after repaying the debt , the rest part will be allocated in sequence that preferred shareholders first, then comes common shareholders.

2.2.The obligations of ordinary shares

Ordinary shareholders enjoy various legal rights ,at the same time, they also must undertake corresponding obligations. According to the regulation of the company law in China, common shareholders shall bear the following obligations.

(1)Comply with the company's articles of association.

(2)Take limited liability for company debts.

Ordinary shareholders take the limited responsibility based on their proportion of shares.This responsibility is indirect, expressing in the way that company is liable to the creditors.

(3)Under non return obligation of equity.

Equity as a company's business capital needs to be used for a long time, as long as the company does not collapse, equity always exists in company, and can't be returned to shareholders. Shareholders who want to cash the holdings of shares can only exchange shares in the circulation market instead of withdrawing money from the company ,otherwise it will damage the interests of the company and other shareholders.

(4)Observe other obligations in the company's articles of association.

3.The pros and cons of ordinary shares

As is known to all, Ordinary share is the most important form of corporate finance. Here we analysis the advantages and the disadvantages of ordinary share from the perspective of corporate finance.

3.1 The advantages of ordinary shares

To compare with other financing way, using ordinary shares to raise capital has the following advantages:

(1)Issued ordinary shares to raise capital is permanent, no due date,no need to return. It is good for company to maintain the minimum of capital and the long-term stable development.

(2)Issued ordinary shares have no fixed dividend burden. To pay or not pay, and how much to pay depend on the company’s earnings and business strategy. Thus, business fluctuations just bring relatively small burden to the company finance. Moreover, as a result of no fixed due debt servicing pressure, so ordinary share has less funding risk.

(3)The capital from issued ordinary share is the most basic funds source of company. It reflects the company's strength, and can be used as the basis of other ways to financing, especially offers protection for creditors and enhances the company's ability to borrow.

(4)Due to the higher expected earnings of ordinary share and in some extent it can offset the impact of inflation. (usually during the period of inflation, real estates always get appreciation as well as ordinary shares), so ordinary share financing is easy to absorb funds.

3.2 The disadvantages of ordinary shares

But using ordinary share to raise capital also has some disadvantages:

(1)The capital cost of ordinary share is higher than other financing methods. First of all, from the perspective of investors, investment in common stock risk is higher, accordingly, so they require a higher return on investment. Secondly, for financing companies, the payments of common stock dividend pay from the after-tax profits, unlike the bond interest as expenses from the tax payment, so no tax credit effect. In addition, ordinary share issuance costs are generally higher than that of other securities.

(2)Issuing ordinary shares will increase the new shareholder, which might be decentralized control of the company.In addition, the new shareholders share the prior accumulated surplus of company, it will reduce the net earnings per share of common stock, which could cause a drop in share price.

4.Ordinary share vs. Preference share

After ordinary share ,we have to mention another type of stock---preference share. Preference share is another type of stock, it’s also another form of corporate financing.

4.1 Differences between ordinary share and preference share

Here we analysis the main differences between ordinary share and preference share.

(1)Ordinary shareholders have right to participate in the management of the firm, while preferred shareholders generally do not have right to participate in the management of the firm.

(2)Ordinary shareholders income depends on the company's profit condition, while the preferred stock returns are fixed.

(3)Ordinary shareholders cannot withdraw shares, shares can only be exchanged in the secondary market, but preferred shareholders can ask company to redeem the preference share according to the attached redemption provisions on it.

(4)Preference share is one important stock of the special stock, it has priority in the company's profit and the distribution of the surplus property.

4.2 The pros and cons of preference share

Preference share is another form of corporate financing, to compare with ordinary share ,here is pros and cons of preference share in financing briefly.

(1)Advantages

● Preference share increases the interest of the owners in an enterprise and enhances the company's strength and debt ability.

● Preference share is the long-term funds, do not need to repayment of capital.

● Preferred shareholders generally no voting right, which will not disperse control of the company.

● Dividend is fixed, the corporate profit ability can create more dividends for ordinary shareholders.

(2)Disadvantages

● Preferred stock financing cost is higher than bonds due to its dividend can't offset pre-tax profit.

● When profitability is not strong, dividend payments will be stressful.

5.Conclusion

In this paper, we discuss the pros and cons of ordinary share from corporate financing perspective and compared ordinary share withe preference share. Both shares have their own advantages and disadvantages in financing. It gives us a clue that when company need capital, the manager should think more about the cost and control right in order to make the best interest during corporate financing.

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