What advantages does issue of debentures provide over the issue of equity shares?
What advantages does issue of debentures provide over the issue of equity shares?
Debentures are financial instruments used by companies to raise long-term debt capital. They imply that the company has borrowed a certain sum of money which it will repay later to the debenture holders. They are considered as fixed income securities as they carry a fixed rate of return and are repayable on a certain pre-specified date in the future.
The following are the advantages of issuing debentures over issuing equity shares.
(a) The issue of equity shares denotes the dilution of ownership of a firm. This is because the equity share holders own specified shares of the company and have voting rights. In contrast, debenture holders do not have any rights in the company. That is, they do not enjoy voting rights or any kind of ownership in the firm. Rather, they are only entitled to a fixed amount as payment. Thus, debentures do not result in any kind of dilution of ownership of the firm. Thus, issuing debentures is more advantageous for a firm than issuing equity shares.
(b) In order to issue shares, a company has to incur huge costs. Besides, it has to pay dividends to its shareholders, which are not tax deductible. On the other hand, a company receives tax deductions on the interest paid to its debenture holders. Hence, issuing debentures is advantageous for a firm in terms of low costs.
(c) Debentures carry a fixed rate of return. This implies that irrespective of the profit earned, the company has to pay only a fixed interest to its debenture holders. On the other hand, a company that issues shares has to pay dividends to the shareholders, which varies with the profit—i.e., the higher the profit, the higher will be the dividends. Thus, companies prefer to issue debentures if they expect to earn higher profits in a year.
Debentures are financial instruments used by companies to raise long-term debt capital. They imply that the company has borrowed a certain sum of money which it will repay later to the debenture holders. They are considered as fixed income securities as they carry a fixed rate of return and are repayable on a certain pre-specified date in the future.
The following are the advantages of issuing debentures over issuing equity shares.
(a) The issue of equity shares denotes the dilution of ownership of a firm. This is because the equity share holders own specified shares of the company and have voting rights. In contrast, debenture holders do not have any rights in the company. That is, they do not enjoy voting rights or any kind of ownership in the firm. Rather, they are only entitled to a fixed amount as payment. Thus, debentures do not result in any kind of dilution of ownership of the firm. Thus, issuing debentures is more advantageous for a firm than issuing equity shares.
(b) In order to issue shares, a company has to incur huge costs. Besides, it has to pay dividends to its shareholders, which are not tax deductible. On the other hand, a company receives tax deductions on the interest paid to its debenture holders. Hence, issuing debentures is advantageous for a firm in terms of low costs.
(c) Debentures carry a fixed rate of return. This implies that irrespective of the profit earned, the company has to pay only a fixed interest to its debenture holders. On the other hand, a company that issues shares has to pay dividends to the shareholders, which varies with the profit—i.e., the higher the profit, the higher will be the dividends. Thus, companies prefer to issue debentures if they expect to earn higher profits in a year.
