Question

One advantage of equity financing is that the corporation is not committed to a fixed cash payout. It can pay dividends when money becomes available. Yet many managers are reluctant to issue equity because of its dilutive effect on EPS, share value, and ownership. Additionally, the market may respond negatively to the announcement of an equity issue. Fully explain these concerns.

Answer 1

Equity issues will be having dilution of control effect for the management because when the management will be issuing additional equity, it will mean that it is dissolving its stake and control in the organisation and it will be less freely taking upon various major decisions.

when the equity shares are issued,it will also mean that there is a higher costs associated with the equity share issue because the payment of the dividend and share repurchases are not tax exempt and dividend are even subject to double taxation so there will be a very high cost of equity in comparison to the cost of debt.

Market will also mostly negatively respond to additional equity issue because they will be fearing that company are losing the control over its operations and they are generating additional capital by issuance of the equity shares so they will be fearful of the future prospect of the company and it would also mean that this will be leading to negative impact on the shares of the company.

So,Due to all these negative aspects related to the equity share financing,the companies are not often issuing equity and they are looking for debt capital because they have an interest tax deduction in debt capital and lower cost of debt as well.