Corporations pursue a variety of goals, including acquisitions, product line expansions and entering new geographic regions. These goals require the company to access financial resources in order to pursue these goals. When corporations need to find additional financing, they often consider issuing bonds or selling shares of stock. Companies who choose to issue bonds encounter disadvantages not experienced by companies who issue shares of stock.
Bonds represent loans to the company. Each bond includes a maturity value, or the value the company will repay to the bondholder; an interest rate, which the company uses to calculate the interest payments; and a term, or the length of time before the company redeems the bond. The investor purchases bonds with the expectation of earning interest income with minimal risk. The company faces a legal obligation to repay the bondholder and records the bond as a liability.
Shares of stock provide shareholders with partial ownership in the company. Each share entitles the shareholder the right to receive cash dividends or stock dividends when the company issues them. The shareholder also holds a legal claim to receive a portion of the assets, if the company liquidates, after the creditors receive their payments. Shareholders, as part owners, receive the right to vote on company issues. The company incurs no repayment obligation and records the shares as an equity component.
One disadvantage of issuing bonds involves the repayment obligation. All bonds issued together expire at the same time. The company faces the burden of paying the total amount of all bonds at one time. When the bond term expires, the company owes the face value of the bond to each bondholder. The company needs to plan for this date by saving money prior to the bond maturity date. If the company issues shares of stock, it does not face the burden of repayment.
Income Statement Impact
Another disadvantage of issuing bonds is the impact on the income statement. Each bond requires the company to make regular interest payments. Each payment constitutes an expense to the company and reduces the company’s net income. If the company issues shares of stock, it records no expense for payments to shareholders.