In this reading, we look at the different types of equity securities, how private equity securities differ from public equity securities, the risk involved in investing in equities, and the relationship between a company’s cost of equity, its return on equity, and investors’ required rate of return.
In 2008, the U.S. contributed about 21% to the global GDP, but its contribution to the total capitalization of global equity markets was around 43%.
Historically, equity markets have offered high returns relative to government bonds and T-bills but at higher risk. The volatility in equity markets was high during key crises such as World War I, World War II, the Tech Crash of 2000-2002, the Wall Street Crash, and the most recent credit crash of 2007-2008. In the recent crash, while the world markets fell by 53%, Ireland was the worst hit incurring losses of over 70%.
An important point to note is that equity securities are a key asset class for global investors.
Common shares represent an ownership interest in a company and give investors a claim on its operating performance, the opportunity to participate in decision-making, and a claim on the company’s net assets in the case of liquidation.
Statutory voting versus cumulative voting
In statutory voting each share is entitled for one vote. In cumulative voting, a shareholder can cumulate his total votes and choose one particular candidate. For example, let’s say that a shareholder holds 100 shares and is supposed to vote for the election of three board members’ position. In statutory voting, he can vote 100 votes for each position while in cumulative voting, he can vote all the 300 votes to a single candidate thereby increasing his likelihood of winning. Cumulative voting is beneficial to minority shareholders.
Different classes (Class A and Class B)
A firm can have different classes of equity shares which may have different voting rights and priority in liquidation. For example: Class A shares would have more votes than Class B shares.
Preference shares are a form of equity in which payments made to preference shareholders take precedence over payments to common shareholders.
Cumulative and non-cumulative preference shares
Participating and non-participating preference shares
Convertible preference shares
Private equity refers to the sale of equity capital to institutional investors via private placement. The key characteristics of private equity are:
The types of private equity are:
Private investment in public equity: A public company, which needs additional capital immediately, sells equity to private investors.