What are equity instruments that commercial banks commonly issue?

Until recently, in most jurisdictions other than the US repurchased shares could not be held in treasury but had to be cancelled. Most EU countries have now changed their law or are in the process of doing so, to allow treasury shares. One argument in favour of them is that companies can manage their equity base more efficiently and so reduce their overall cost of capital.

Most preference shares are cumulative, meaning that ordinary dividends cannot be paid until all preferred dividends have been paid for all past years. Preferred shares do not generally carry voting rights, although they may get them in some cases if preferred dividends have not been paid. Other features which can be attached to preference shares include:

• Perpetual or redeemable
• Cumulative or non-cumulative
• Floating rate coupon, fixed coupon or increasing coupon
• “Call”able/”Put”able
• Convertible (into shares of the issuer)
• Exchangeable (into securities issued by another company)

The features of these should be reviewed carefully. Although this instrument is subordinated to senior debt in liquidation, it could be “put” or redeemed (or its coupon raised to a level unsustainable for the issuer, and “called”) before any debt comes due for repayment.

Issuing equity

Privately held/state owned companies

Many start-up companies will be held by the management, their friends and family. As the company becomes more established and needs capital to finance growth it may seek venture capital from a specialist investor. Normally venture capitalists aim to realise their investment through a trade sale or flotation of the company on a stock market. The timing varies depending on market conditions but can be between 3 and 7 years of initial investment. In the past the main driver for flotation was access to more finance than could be provided privately but increasingly the venture capital/private finance investors have very large amounts available to invest and in some countries there is a strong trend towards taking public, listed companies private.

Many companies in industries that are strategically or politically important (e.g. utilities, transport) or in certain countries have been state owned for many generations. There is an increasing trend to privatise these companies through flotation of part or all of the shares.

Initial Public Offering (IPO), flotation or unseasoned issue

This is the first issue of shares of a company to the public and the resulting quotation/listing of the shares on a stock exchange. A company can float any proportion of its shares, although there is a minimum amount of shares that the market would consider sufficient to provide adequate liquidity. The shares floated can be newly issued or already issued and held by existing shareholders who are making them available to the market.

Secondary placing or seasoned issue

This is any subsequent issue of more shares to the public. Depending on the stock exchange rules shares can be offered generally or, as in the UK, existing shareholders have pre-emption rights and must be offered any new shares before new investors (a “rights” issue).

American Depository Receipts (ADRs)

Instead of buying shares of foreign-based companies in overseas markets, US investors can buy shares in their home market in the form of an ADR. These are receipts for the shares of a foreign-based company held by a (usually US) bank and entitling the shareholder to all dividends and capital gains/losses. The investor will still carry the currency and country risk of the issuer.

Dividends/Share buy backs

Traditionally companies have considered it important to have an established dividend policy often targeting above inflation annual increases and at least maintaining dividend pay out at the same level of the previous year. lt may do so even where profits for the year are insufficient and the reserves have to be raided, to signal that current problems are temporary. However changes in tax law and increasing pressure from investors for companies to return cash to them in a tax efficient manner have led to more flexible approaches.

Share buy-back have increased in popularity as a method of returning cash to shareholders, although not all jurisdictions yet allow them. Investors do not expect buy-backs to occur on a regular basis which increases the company’s flexibility. A buy-back can also be used as way of increasing gearing to improve the return on equity and support the share price. For debt investors an unexpected share buyback programme can significantly change the risk of his investment.

Dividends do not have to be paid in cash. Stock- or scrip-dividends i.e. payment in shares, are sometimes offered to shareholders as an alternative to cash. They can be attractive to companies making reasonable profits but short of cash. Whether they are attractive to investors or not usually depends on the tax regime. In some countries cash dividends are kept very low due to the absence of capital gains tax for private investors (e.g. the Netherlands).

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