Q.Explain Equity Shares, Preference Shares and Debentures as sources of finance, bringing out the points of difference between them.

This is one of the most commonly asked essay questions in the AP Intermediate Commerce paper on this chapter, comparing the three main instruments of company finance.

A complete answer explains each instrument and then compares them point by point.

Equity shares, preference shares and debentures are the three principal instruments through which a company raises its long-term capital, and each carries a different bundle of rights and obligations.

Equity shares represent ownership of the company. Equity shareholders enjoy voting rights and are entitled to dividend only after preference shareholders and creditors have been paid, and the rate of their dividend is not fixed but depends on the profit earned and the board's decision; they bear the highest risk but also the highest potential reward. Preference shares also represent ownership, but of a preferential kind: preference shareholders receive a fixed rate of dividend ahead of equity shareholders, and a preferential return of capital on winding up, but they ordinarily have no voting rights. Debentures, unlike both types of shares, represent borrowed money; a debenture holder is a creditor, not an owner, of the company, entitled to a fixed rate of interest at stated intervals and to repayment of the principal on the due date, and carrying no voting rights or share in profit beyond the fixed interest promised.

Comparing the three: in terms of status, equity and preference shareholders are owners while debenture holders are creditors. In terms of return, equity dividend is variable and uncertain, preference dividend is fixed but paid only if profits allow, and debenture interest is fixed and must be paid regardless of profit. In terms of risk to the company, equity carries the least fixed burden and debentures the most, with preference shares in between. In terms of control, only equity shares normally carry voting rights. In terms of priority on winding up, debenture holders (especially secured ones) are paid first, then preference shareholders, and equity shareholders last, out of whatever remains.