Limitations of Issuing Common Stock
What are the Limitations of Issuing Common Stock?
- There is a limit to the number of shares a company can issue. The number of authorized shares is set in the company‘s corporate charter and may not be exceeded without the approval of shareholders. Each issuance of new shares dilutes the ownership share of existing shareholders and will also decrease the value of each share. Thus, as more shares are issued, the amount of money raised from each issuance will be smaller.
- The cost of issuing stock may be higher than the cost of issuing debt, largely due to the fact that fees paid to investment bankers for the issuance of equity securities are usually substantially higher than the fees paid for the issuance of debt securities. The higher fees are primarily a result of the cost of selling equities to the public. Most debt securities are privately placed with institutional investors at a small cost. Equities, however, require substantial selling effort and the cost is therefore significant.
- In addition to the issuance cost, “going public” with an initial public offering is complex and timeconsuming, and the issuing company becomes subject to considerably more regulation due to being a publicly-held firm.
- Since common stock is the riskiest security from an investor’s viewpoint, investors expect the highest return on their equity investments. Therefore, the issuance of too many shares can move the average cost of capital above the most optimal level for the firm.
- Issuing new shares of stock dilutes the voting power of existing stockholders, which may also increase the return required by the investors and thus the cost of the equity.
- Unlike interest on bonds, distributions made in the form of dividends are not a tax-deductible business expense to the payer. The corporation pays income tax on the income that it distributes as dividends, and the dividends are at least partially taxable to the recipients (the shareholders) as income. Therefore, distributed corporate profits are subject to double taxation, meaning they are taxed twice, once to the firm as taxable income and again to the shareholder as dividend income.