Capital Structure

The capital structure of the joint stock company relates the way in which this type of company raises its long term capital. It is not proposed to go into great detail on the forms in which capital can he raised. However, a cursory examination of the types and characteristics of the securities issued by a joint stock company will be of value before we commence on capitalisation schemes.

Types of securities

Earlier in this chapter we noted that one of the chief advantages of the joint stock company was its ability to raise vast amounts of capital from a large number of people who might individually subscribe in very small amounts; the pooling of funds in this way making possible large scale enterprise. In exhange for their investment the subscribers become shareholders or part-owners of the enterprise and besides having a right to share in its profits they also have a voice in its control. This form of investment became known as the ordinary share.

Ordinary Shares

Holders of these shares have an equal right to share in the profits and the assets of a "wound-up" company after prior claims of Preference shareholders and Debenture holders have been met. Normally these shares also carry voting rights.

Whilst ordinary share capital tends to dominate the capital structure of the joint stock company the majority of companies in the U.K. have adopted other forms of capital. The basic reason for this is that the ordinary shareholder whilst accepting the risks of a company failure desires the best return possible on his investment. If the company can borrow money from other sources at low interest rates, the difference between the return the company makes by using that money and the interest they have to pay to borrow it adds to the profits of the ordinary shareholder. Secondly, raising money by issuing securities which confer a variety of rights and benefits on the investor will widen the appeal of such securities and improve the revenue raising prospects of the company. A brief sketch of some of these other securities and their characteristics follows:

Preference Shares

There are many varieties of these, each with differing rights and benefits. The holders of preference shares are usually entitled to a dividend at a fixed percentage out of profits in priority to any other class of shareholder and usually have preferential right to the return of their capital when a company is wound up. However, these shares rarely carry voting rights.

Debentures

These are not shares in the company and therefore the holder of a debenture is not an owner of the company. Debentures are basically securities which have been issued by the company in consideration for a loan. They carry fixed interest rates and give no right to voting in company meeting. Since debenture holders are creditors of the company they rank with other creditors before shareholders in the assets of the wound-up company.

One very important point is that debenture holders are entitled to their interest whether profits are made or not and can often appoint a receiver to enforce their security when nonpayment occurs.

Having briefly sketched the characteristics of the main types of security issued by the joint stock company we can now examine more closely the relationship between ordinary shares, preference shares and loan capital in the company balance sheet. This relationship is normally referred to as "gearing" though in the USA it is often called "leverage".

Capital gearing

The "gearing" of a joint stock company's capital is broadly the ratio of its capital raised by fixed interest securities such as Debentures and Preference stock, to its equity or ordinary share capital.

If the company has a high ratio of fixed interest securities to ordinary shares then it is said to be highly geared:

CAPITAL
60% Debenture	60,000	}	A (fixed interest stock)
20% Preference Shares	20,000
20% Ordinary Shares	20,000		B (equity capital)
	£ 100,000

The gearing ratio A to В = 80,000 : 20,000 or 4 : 1.

A company, however, with a low proportion of fixed interest stock to equity capital is said to be in "low gear" and might display the following capital structure:

CAPITAL
10% Debenture	10,000	}	A (fixed interest stock)
10% Preference Shares	10,000
80% Ordinary Shares	80,000		B (equity capital)
	£ 100,000

The gearing ratio A to В = 20,000 : 80,000 or 1 : 4.

Note that few companies maintain the same gearing for long periods as economic conditions often make it advantageous to restructure their capital. A company with the same proportion of fixed interest stock to ordinary share capital is often in the process of moving from high to low gear or vice versa and can be referred to as an "evenly" geared company.

CAPITAL
30% Debenture	30,000	}	A (fixed interest stock)
20% Preference Shares	20,000
50% Ordinary Shares	50,000		B (equity capital)
	£ 100,000

The gearing ratio A to В = 50,000 : 50,000 or 1 : 1.

Key words and word combinations of the text.

sole trader	to be liable
partnership	unlimited liability
non-corporate business	company
sole proprietor	secret partner
limited partnership	sleeping partner
corporate business	nominal partner
separate legal entity	stockholder
shareholder	stocks
limited liability	bonds
investment	dividends
to issue shares	public corporation
assets	voting right
board of directors	profit
public joint stock company	full partnership
private joint stock company	mixed partnership
monopoly	trust
holding company	horizontal integration
merger	vertical integration
conglomerate	lateral integration
integration	circular integration