8.2 Ordinary (equity) capital
For the business, the position is the opposite of that of the investors: sources of
finance that are relatively risky (from the business’s point of view) tend to be cheap in
terms of servicing cost; safe sources tend to be expensive. The level of returns required
by secured lenders is relatively low but the existence of such loans represents, as we
shall see, a potential threat to the welfare of the shareholders. Equity investors expect
high returns, but issuing additional ordinary shares does not tend greatly to increase
the risk borne by the original shareholders.8.2 Ordinary (equity) capital
Equity financing is overwhelmingly the most important source of finance in the UK
corporate private sector. Both as regards the cumulative financing arrangements and
the raising of new capital, equity finance has tended to be by far the largest source.
Equities seem to attract a wide range of investors, both private and institutional.
(See Table 1.1, page 11 for the ownership of the shares of London Stock Exchange
listed businesses.) Equity finance dominates most businesses’ financing. It should be
remembered that most equity finance comes from businesses retaining profit (rather
than paying it all out as dividends), not from issues of new shares.The nature of equity
The ordinary shareholders are the owners of the business and, through the voting
rights attaching to their shares, they exercise ultimate control over it.Figure 8.1
The risk/return
relationship for
various types of
security
The more risky the security the higher will be the expected return. Thus, for example, short-
dated UK government securities, which tend to engender very low risk, command only a very
small expected risk premium over the risk-free rate. The shares of commercial businesses
(corporate equities) tend to command quite a high expected risk premium.