Corporations issue stock shares to raise money. Each share represents a tiny ownership piece of the corporation, and people who buy the shares receive the right to benefit from their ownership stake. The major benefits for shareholders are the ability to receive dividends — payments from the corporation — and the right to participate in the growth of the company through higher stock prices. From the viewpoint of the corporation, issuing stock has a number of pros and cons that it evaluates before deciding whether to proceed and how many shares to issue.
Advantages of Issuing Shares
The most important reason for corporations to issue shares is to raise money, which is called capital and can be used to pay for the operations and growth of the issuer. Unlike bonds, the stock shares are not debts of the corporation and don't have to be repaid. Furthermore, corporations can use share sale proceeds however they want, without any strings attached, whereas lenders might place conditions on the money they lend that partially tie the corporation's hands.
Video of the Day
Share issuance is flexible because the corporation can decide how many shares to issue, when to issue them, and how much to initially charge for each share. The corporation can issue additional shares to raise more money after the initial public offering, which is the original sale of shares to the public. Corporations can issue different classes of stock that provide different rights to buyers, including the right to receive dividends and to vote about the management of the company.
Another flexible aspect of stocks is that the corporation can decide not to issue any dividends, or to change the timing and amount of dividend payments. For example, if the corporation runs short of cash, it can decide to skip one or more dividend payments until conditions approve. If it had raised money from debt instead of stocks, it would not have the flexibility to skip payments to the lender. Failure to repay debt can force a corporation into bankruptcy, a threat that doesn't apply to a failure to issue dividends.
A corporation can repurchase issued shares, which helps support or increase the share price since fewer shares are available to meet demand. Corporations view rising stock prices as confirmation they are doing a good job, and the higher prices are a reward to shareholders who sell their shares for a profit.
Disadvantages of Issuing Stock
It costs money to issue stock, and often, it costs more to raise money from issuing shares than it costs to borrow money, especially after taking taxes into account. The corporation can deduct the interest it pays on its debt from taxes, but cannot deduct dividends it pays out or the money it spends to repurchase shares. The mechanics of a public share offering are complicated, but a certain percentage of the money raised goes to financial firms that help sell and distribute the shares, and that cost is usually heftier than the cost of arranging a loan.
Another disadvantage from the viewpoint of the original owners who control the corporation is that share issuance gives voting rights to shareholders, who can vote to change corporate policy and even replace the board of directors. Moreover, share issuance makes the corporation vulnerable to a hostile takeover by a competitor, as the acquirer might be able to go into the stock market and buy up the majority of voting shares.
The management of a corporation that issues shares to the public must publicly disclose financial and operational details, a requirement that costs money and might reveal information the corporation would rather keep secret.
Finally, a corporation that issues additional shares after the initial sale is diluting the value of existing shares, which will usually cause the share price and dividends per share to fall. This might anger existing shareholders and result in a fight for corporate control.