Part 03

Part-03
Equity Shares
&
Preferred Shares
1
Introduction
Equity shares  Shares of common stock of a

company  Represent financial claims
• asset for the shareholder • liability for the

• equity shares confer issuing corporation
ownership rights on the
shareholders
2
Copyright Tarheel Consultancy Services
Shareholder’s Stake
 Shareholder is part owner of company

 Stake = fraction of the total share capital of
the company
3
Cash Flows from Shares
 Dividends
 When a firm makes a profit it will
typically pay out a fraction of it in the
form of cash to the shareholders.
4
Dividends
 Dividends are not contractually

guaranteed
 Unlike interest on bonds, the rate of
dividends is not fixed.
5
Dividends (cont…)
• Shareholders cannot • The company is

demand dividends as a not obliged to pay
matter of right dividends
•BOD decide
whether dividends
should be paid, and
if so, how much
6
Dividends (cont…)
 Dividends can fluctuate substantially

from year to year.
 Firms opt to maintain dividends at a steady
level, even in years of financial hardship

To avoid sending distress signals to the
market, which could cause the market value
of the firm to plunge
7
Retained Earnings
 It is not essential for a firm to have a profit in

the year in which it chooses to pay a dividend
 Profits accumulated from previous years can be
used to pay dividends
 Accumulated profits are a part of the Reserves &
Surplus account on the liabilities side of the
balance sheet
8
Retained Earnings (cont)
 Reserves and Surplus account =
accumulated profits
 x(profit) = Dividends
 y(profit) = Retained Earnings
9
Shareholders  residual claimants
Bondholders Shareholders
Bondholders have to be Only then can the firm
paid the contractually consider the possibility of
promised rate of interest rewarding its shareholders
by way of dividends
In the event of liquidation Only if something were to
or bankruptcy, bondholders remain, will the
must be paid their dues in shareholders be entitled to
part/full depending on the compensation
proceeds from the sale of
assets 10
Maturity
 Equity shares never mature

 Every firm is set up as a Going Concern
 An entrepreneur will not set up a firm with the
stated objective of winding up after a given
period
 If firm is expected to stay alive for ever, its
shares never mature.
11
Rights of shareholders
12
Rights of Shareholders
1. Equity shareholders have voting rights.

 A say in the election of the Board of Directors
1. Shareholders have limited liability
 Their financial commitment to the firm is limited
to the extent of their shareholdings
 In the event of financial difficulties,
company/creditors cannot stake a claim on the
personal assets of the shareholders
13
Voting Rights
 Most equity shares carry voting rights

 Right of shareholders to elect the directors of
the firm
 Common arrangement is 1 vote per

share.
 In practice shares with differential voting
rights are issued
14
Proxies
 To be eligible to vote, the shareholder
must be the Owner of Record
 Name must be present in the register of
shareholders on the prescribed Record
Date.
15
The Record Date
 Is usually a few days prior to ‘date of
the meeting’ of shareholders or ‘date of
actual voting’ takes place
16
Proxies (cont…)
 Person whose name figures in the register

on the record date may have sold his
shares prior to ‘date of meeting’
 The only way the current shareholder can vote
is if he is given proxy by the shareholder of
record
 In practice, a shareholder can always give a
proxy to someone else, even if he continues
to be the owner of the share
17
Proxies (cont…)
 Why are proxies allowed?

 Most shareholders cannot be realistically
expected to attend meetings and vote in
person
 Companies routinely send out proxies
 Shareholders can fill these and authorize
representatives of the management to vote
on their behalf
18
Proxies – reason (cont…)
 In practice managers solicit proxies from

absentee shareholders for a valid reason
 A quorum is required by law for a meeting to be
legally recognized
 %shares represented at the meeting should
exceed a prescribed minimum
 Shareholders are encouraged to be present or
have themselves represented by proxy
19
Par value & Book value
20
Par Value vs. Book Value
 Equity shares have a Par Value also
known as the Face Value / Stated Value
21
Par value (cont…)
Historically Today
Corporate assets were part Par values have no
of a trust fund protected practical significance
by BOD
The par value was Some shares may not
supposed to represent this even have a par value
fund
Standard par values like Can be fixed at arbitrary
$10 / $100 were specified levels e.g. 10c
22
Reasons for Low Par Values
 In some states in the U.S., the
incorporation fees for the firm are a
function of the par value of the shares
being registered
 Companies issue low/no par value stock to
minimize these expenses
23
Book Value
 Book value is the value of the assets behind a

share, as per the balance sheet.
 Book value = (par value + any share premium +
retained earnings) / no. of shares outstanding
 Book value may differ substantially from the

market value of the share (price of share on the
stock exchange)
24
Classified shares
25
Classified Common Stock
 Companies sometimes issue different
categories of stock.
 Reason for this being they wish to confer
different voting rights on different
categories of shareholders
26
Example - Ford
 Ford Motor Company has 2 classes of shares

 Shares available to the public carry voting rights
 As of 1998 1114 million+ shares were outstanding
 Of these, 70.90 million shares were classified as Class
B
27
Example – Ford (cont…)
 Class B shares are owned by the Ford family

and certain key officers
 These shares have weighted voting rights that
allow them to control nearly 40% of the votes.
 Class B shareholders have always voted as a
unified block.
 Thus the majority of shareholders cannot
easily force a decision on the company
28
Classified Shares (cont…)
 For many years the NYSE did not

permit non voting shares to be listed
 This policy has been subsequently
relaxed.
29
Dividend related dates
30
Dividend Related Dates
 In the context of a dividend payment,

there are four dates that are important
1. The Declaration Date
2. The Record Date
3. The Ex-dividend Date
4. The Distribution Date
31
1. Declaration Date
 The date on which the decision to pay a
dividend is ‘declared’ by the directors
and the amount of the dividend is
announced
32
2. The Record Date
 The dividend announcement will

mention the Record Date
 Only those shareholders whose names
appear on the register of shareholders as of
the record date, will be eligible to receive
the forthcoming dividend
33
3. The Ex-Dividend Date
 This is specified by the exchange on

which the stocks are traded
 An investor who purchases the stock on
or after the ex-dividend date will not be
eligible for the dividend
34
The Ex-Dividend Date (Cont…)
 The ex-dividend date will be such that
 share transactions prior to that date will be
reflected in the register of shareholders as on
the ‘record date’
 transactions on or after that date will be
reflected on the register only after the ‘record
date’
 This date will be set a few days before the
share transfer book is scheduled to be
closed.
 This to enable the registrar to complete all the
administrative formalities
35
The Ex-Dividend Date (Cont…)
 This date is a function of the settlement
cycle followed by the exchange.
 For instance the NYSE follows a T+3 cycle.
 Trade occurs on day T
 Delivery of shares to the buyer on day T+3
 Payment of funds to the seller on day T+3
 A transfer of shares 2 days before the
‘record date’ or later will not be reflected in
the books on the record date.
 On the NYSE the ‘ex-dividend date’ is
specified as 2 business days prior to the
record date announced by the firm.
36
Cum-Dividend and Ex-Dividend
Prior to the  The shares will be traded cum-

ex-dividend dividend
date  This implies that the buyer of the
share is eligible for the forthcoming
dividend
On the ex-  The shares will begin to trade ex-

dividend date dividend
 Buyers of the share on or after this
date will not be eligible for the
approaching dividend
37
Ex-Dividend Prices
In theory  On the ex-dividend date the share

price ought to decline by the amount of
the dividend. E.g.
Cum-dividend price is $50 per share
Quantum of the dividend is $2 per
share,
The share should trade at $48 ex-
dividend.
In practice  The price decline may not be exactly

38
4. The Distribution Date
 This is the date on which the dividends

are actually paid or distributed.
39
Stock dividend
40
Stock Dividends
 These are called Bonus Shares in India.

 Dividend is paid in the form of shares of
stock rather than in cash
41
Stock Dividends (cont…)
 Entails the issue of additional shares

without monetary consideration
Reserves Share
& Surplus funds transferred Capital
account account
 This is called the Capitalization of

Reserves
42
Stock Dividends (cont…)
 From a theoretical standpoint, stock
dividends do not create any value for
their shareholders.
43
Example
 A shareholder owns 500 shares of CISCO
 CISCO has issued 500,000 shares in all
 This investor owns 1/1000th of the firm
 The firm announces a 10% stock dividend
 It will issue 1 share for every 10 existing shares
 The firm will issue totally 50,000 shares
 The investor will receive 50
 After the issue shareholder will hold 550 shares
 This is 1/1000th of the total number of shares
outstanding
 Shareholder’s stake in the company will remain
unaltered
44
Ex-Bonus Prices
In  For the firm, the additional shares do not
theory represent:
Either a change in its asset base, or
A change in its earnings capacity
The issue of additional shares should lead to

a decline in the share price.
The share price prior to the bonus issue was
$55
The ex-bonus price, P, should be such that:
500000 x 55 = 550000 x P ⇒ P = 50

In  The ex-bonus price may not fall
practice The market may interpret the bonus issue as
a signal of enhanced future profitability. 45

Rationale
 Companies usually refrain from

lowering their cash dividend payouts,
unless they are forced to
 When a bonus issue is declared
 The number of shares will go up
 In future cash dividends will have to be
paid on a greater number of shares.
46
Rationale (cont…)
 If ‘dividend payout per share’ is not

likely to decline then the firm must be
anticipating greater profitability
 This kind of an interpretation will boost
the demand for the shares.
 The enhanced demand will cause share
prices to be higher than the theoretically
predicted value
47
Stock Dividends (Cont…)
 Sometimes, a firm may declare a bonus

issue prior to the payment of a cash
dividend.
 If so the impact on the share price will be as
illustrated in the following example.
48
Example
 CISCO has 500000 shares outstanding

 Shares are trading at $55 each
 CISCO announces a cash dividend of $2 per
share & a bonus issue of 10%
 The dividends will be paid on the additional
shares as well.
 The cum-bonus cum-dividend price is $55
49
Example (Cont…)
 Market value of 500,000 shares is:
 500,000 x 55 = 27,500,000
 Theoretical market value of 550,000
ex-bonus cum-dividend shares will also
be 27,500,000
 Since the bonus issue per se does not add
any value.
 Theoretical ex-bonus ex-dividend price
will be:
 {27,5000,000 – (2 x 550,000)} / 550,000 =
$48
50
Treasury stock
51
Treasury Stock
 Shares which were issued to the public
 have been subsequently reacquired
by the company  either through an
open market purchase or via a tender
offer
 These shares:
 Have no voting rights
 Receive no dividends
 Are not used to compute EPS
 Such shares are used for purposes such
as ESOPs
52
Why repurchase?
Situation Why repurchase?

In difficult markets shares Companies can buy a
often trade below their dollar’s worth of assets
book value for less than a dollar
People often acquire  Shares are purchased to

voting control in order to thwart corporate raiders.
sell the assets of the  By stashing away
company piece by piece, treasury stock,
often to its competitors managements can
acquire greater control
53
Why repurchase? (cont…)
Situation Why repurchase?
A company is generating By repurchasing shares

more cash flows than can and returning capital to
be profitably invested. If it shareholders long term
declares a special capital gains are taxed at
dividend it is likely to be a lower rate
taxed at the normal rate
54
Stock split
55
Splits & Reverse Splits
 Meaning of a stock split

 An n:1 split  n new shares will be issued to
an existing shareholder for every old share
that he holds
 E.g. a 11:10 split  a holder of 10 existing
shares will receive 11 shares
 This is analogous to a 10% stock dividend
56
Differences
Theoretically, stock splits and stock dividends
are mathematically equivalent.
Stock dividends Stock splits
Stock dividends entail the Stock splits do not
capitalization of reserves
The par value of an existing

share is reduced – no. of shares
will increase proportionately
The product of the par value and
the no. of shares outstanding or
Issued Capital will remain
57
unchanged
Price Behaviour
 The share price after a split will behave

exactly as in the case of an equivalent
stock dividend.
58
Example – Price Behavior
An investor is holding 500

shares of CISCO worth $55
each
The company He will have 550

announces a 11:10 shares after the
split split
These will theoretically be

worth $50 each
59
Why Split Shares?
1. Companies generally go in for a split

when the share price becomes too high.
 If so the scrip is considered to be out of reach
for small/medium investors
 What is high is subjective  the belief is that
managers have a feel of the ‘popular price
range’
 the range in which the stock should trade to
attract enough investor attention.
60
Why Split Shares? (cont…)
2. Investors normally prefer to trade in
round lots
 round lot  100 shares
 odd lot  <100 shares
 At very high prices, small/medium
investors may be unable to afford odd lots.
61
Reverse Splits
 If a company perceives its stock price to
be too low it can go in for a reverse split

 an n:m split  n > m
 an n:m reverse split  n < m
62
Example
An investor is holding 500
shares of CISCO worth $55
each
CISCO announces a He will have 450

9:10 reverse split shares after the
split
Post reverse split price would

be:
500,000 x 55
P = ____________ = 61.11
450,000
63
Rationale for Reverse Splits
 Exchanges like the NYSE discourage the

listing of securities which are
consistently trading at very low prices
 Low prices have a tendency to attract
inexperienced traders with unrealistic price
expectations, who could get their fingers
burnt.
64
Rights issue
65
Pre-emptive Rights
 Laws governing companies usually

require that existing shareholders be
given pre-emptive rights to new shares
that are being issued for a monetary
consideration, as and when they are
issued.
 Enables them to maintain their proportionate
ownership in the company.
66
Rights Issues (cont…)
 Often, price of rights issue < prevailing

market price of the share.
 When this happens, the rights acquire a
value of their own.
 An existing shareholder can either exercise
his rights or else sell them to someone else.
67
Example – Value of a Right
Assume that CISCO has 500000
shares outstanding and
announces a rights issue
Shareholders are
So in all 50000
entitled to one new
shares will be issued
share for every 10
shares that they hold
Assume that the prevailing

share price is $50 and that the
additional shares are being
offered at $40 each
68
Example (cont…)
The market value of the firm
prior to the rights issue is:
500,000 x 50 = 25,000,000
The post issue theoretical The ex-rights price should

firm value will be: be:
25,000,000 + 50,000 x 27,000,000
40 = 27,000,000 ________________ = 49.0
550,000
Considering that fact that a share

worth 49.09 is being made
available at 40, the value of the
right is 9.09
69
Losers?
 Are the existing shareholders losing? No!

 The ex-rights price is 49.09 which is less than
the cum-rights price of 50
 The shareholders are being given an
opportunity to buy new shares at $40
 This opportunity compensates for the decline
in the share price
70
Example – Losers?
Take the case of an investor
who has 50 shares
If he exercises his
The value prior to the rights he can acquire
rights issue is $2,500 5 additional shares by
paying $40 for each
The value of his shareholdings

after the issue will be:
49.09 x 55 = 2,700 = 2,500 + (5 x
40) There is no dilution of
value
71
Renunciation
 The shareholder can always renounce

his rights in favour of someone else if
he chooses not to exercise them.
 The rights can be sold for $9.09 each
 The value of his position after the
renunciation will be:
 49.09 x 50 + 9.09 x 5 = 2,500
72
Ex-rights Price
 The ex-rights price is often higher in

practice (than the theoretically predicted
value)
 The rights issue may be perceived as an
information signal by investors
 The very fact that additional shares are being
issued may be construed as a signal of
enhanced future profitability
73
Why belief of future profitability
1. The belief that the new funds will be used

for more profitable projects
2. Since cash dividends are usually maintained
at steady levels the issuance of additional
shares is a sign on increased profitability
from existing ventures.
 Both these factors could cause the demand
for the shares to rise.
74
Preferred shares
75
Preferred Shares
 These shares represent ownership in

a corporation
 However they do not carry voting
rights.
76
Why Preferred?
 The term “preferred” connotes that such

shares have certain associated privileges.
 Dividends must be paid to the preferred
shareholders before equity holders.
 If the firm is liquidated the preferred shareholders
have to be paid in part or in full, before the
balance if any can be paid to the equity holders.
77
Dividends
 These shares carry a fixed rate of

dividends.
 E.g. $3.50 preferred  means that shares
carry a dividend of $3.50/share
Or
 E.g. 3.5% preferred  a dividend of $3.50
on a par value of $100
78
No Growth
 Preferred shares offer an opportunity for

generous dividend returns with no
growth opportunities.
79
Why no growth?
Because of better prospects

Why do equity prices
for the firm
increase?
Hence greater anticipated

Preferred shares carry fixed
profits will have no
dividends
consequence for such
shares
80
Why no growth?
Since the rate of

Does this mean that such
dividends is fixed, they
shares will never display NO
are a form of a fixed
fluctuations in price?
income security - just like
a bond
Declining interest rates will

lead to higher share prices.
Rising interest rates will
lead to lower prices
81
Callable Preferred Stock
 In a period of high interest rates, preferred

shares have to compete with other debt
securities to offer high dividend rates.
 The firm may feel that this is a passing phase
 In future it could issue shares with a lower rate of
dividends.
 If so, it could issue Callable Shares
82
Callable…(cont…)
 Such shares can be recalled or retired

at a predetermined price.
 Shares without this feature are said to
be non-callable.
83
Callable shares
Adv. for investors Disadv. for investors
Sometimes companies offer The ability to recall works

shares which cannot be against the investors  shares
recalled for the first five to ten will be recalled when rates are
years falling, which is when the
holders would like to hold on
to the shares
A conversion option is another

way of sweetening a preferred
issue
84
Convertible Preferred Shares
 A company believes its prospects are
bright in medium/long term and its equity
shares will appreciate in value.
 It can issue preferred shares with option to
convert to equity shares ; at a later date at a
pre-specified conversion rate.
 If investors perceive this option to be
beneficial they may accept these shares at
a lower rate of dividend than they would
otherwise.
85
Example
Alpha corporation has issued
The conversion ratio is
preferred shares each of
therefore 5:1
which is convertible into 5
equity shares
Assume that the preferred If PP = 5PE then the two

shares are trading at PP types of shares are said
and that the equity shares to be at parity
are trading at PE
E.g. if the preferred shares are

trading at $125 & the equity
shares at $25 then this would be
the case
86
Example (cont…)
 Once parity is reached
 Dividend on the converted shares >
Dividend on the preferred shares  then
the shareholders will normally convert.
Preferred shares Equity shares

Preferred shares are Equity shares are paying
paying a dividend of $10 $2.20
If investor holds on to the An investor who converts,
preferred shares he will would receive $11 from
receive only $10. the 5 equity shares after
conversion
87
Convertible…(cont…)
 Trade above parity

 If preferred share > value of the converted
equity shares
 E.g. if the preferred share = $140 & equity
shares = $27 each,
 Then the share is said to be trading above
parity.
 Obviously no one will convert in this case.
 They would rather sell the preferred share
and buy the equity shares.
 In the process they will save some money
88
Convertible… (cont…)
 Arbitrageurs will step in when

 Value of the equivalent equity shares >
value of the preferred share
 This will cause the prices to reverse to
parity as the following example will
illustrate.
89
Example – Convertible…
Assume the preferred share
is selling at $125 & the
equity shares are selling at
$27 each
An arbitrageur will buy the Outflow = 125

preferred share and will Inflow = 27 x 5 = 135
immediately convert it to 5 Profit = $10
equity shares which he will
then sell
As the arbitrageurs step up their

activity the price of the preferred
shares will rise while that of the
equity shares will fall.
Eventually parity will be 90
Cumulative Preferred Shares
 In the case of non cumulative preferred shares

 An unpaid or missed dividend is lost forever
 In the case of cumulative preferred shares;

 All outstanding dividends including the current
dividend must be paid before any dividends can be
paid to equity holders
91
Illustration
 Convergys has issued

 1 preferred share with a dividend of $5 to Harry
 1 equity share to Sally
 They are the only two shareholders.

 The company has a policy of paying the entire
earnings for the year as dividends.
92
Earnings over a 5 Year Horizon
Year Convergys Earnings

($)
2000 5
2001 2
2002 8
2003 0
2004 12
93
Dividend Distribution
The Case of Non Cumulative Shares
Year Earnings Preferred Common

($) Dividends Dividends
2000 5 5 0
2001 2 2 0
2002 8 5 3
2003 0 0 0
2004 12 5 7
94
Analysis - The Case of Non
Cumulative Shares
2000 5 This is just adequate to There is nothing
pay the preferred left for the
shareholder equity holder
2001 2 The entire amount will go The equity

the preferred shareholder. holder will
He is eligible for $5 but obviously
the earnings are receive nothing
inadequate
2002 8 Preferred shareholder will The balance $3 95

Analysis - The Case of Non
Cumulative Shares

Dividends Dividends
2003 0 The company has Neither

nothing to distribute shareholder will
receive anything
2004 12 $5 will go to the Balance $7 to the
preferred shareholder equity holder
96
Dividend Distribution
The Case of Cumulative Shares

2000 5 5 0
2001 2 2 0
2002 8 8 0
2003 0 0 0
2004 12 10 2
97
Analysis - The Case of
Cumulative Shares
2000 5 This will be adequate to The equity
pay the preferred holder will get
shareholder nothing
2001 2 The entire earnings will go The equity
to the preferred holder will get
shareholder nothing
2002 8 Only $5 is required for The equity
paying the preferred holder will
shareholder. But there is receive nothing
backlog of $3 from the
previous year.So the entire
amount ofTarheel
Copyright $8Consultancy
will go to the
Services
98
Analysis - The Case of
Cumulative Shares

Dividends Dividends
2003 0 Neither shareholder will Neither
receive anything shareholder will
receive anything
2004 12 $10 will go to the The remaining $2
preferred shareholder. will go to the
Out of this $5 will be for equity holder
this year and the
balance $5 will be the
arrears for the previous
year.
99
Adjustable Rate Preferred Shares
 They are similar to floating rate bonds

 The dividends are not fixed but are subject
to periodic revision based on a pre-specified
formula.
100
Tax Advantages
Preferred shares Bonds
One would expect preferred One would expect
shares to trade at a lower bonds with an identical
price than bonds since these interest rate to trade at
shares are inherently riskier a higher price.
than bonds
In the U.S. 70% of the Interest from bonds is
dividends received by fully taxable
corporate holders of preferred
shares are tax free
The tax rate for corporations
101
is 34%. So the effective tax
Tax Advantages (cont…)
Preferred shares Bonds

The after tax return is The after tax rate of return
greater is lower
Preferred shares trade at a Bonds trade at a lower
higher price than price than otherwise
otherwise similar bonds similar preferred shares
Note: This tax benefit is not available for individual investor
102
Dual / Multiple listing
103
Dual / Multiple Listing
 Refers to the listing of the shares of a
company on the markets of more than one
country
104
Advantages of Dual Listing
1. Companies must meet the securities market

regulations of the foreign country and foreign
stock exchange.
 This very often requires a company to comply with
stringent disclosure norms
 To list its shares on a U.S. exchange, an Indian
company has to comply with SEC and
NYSE/Nasdaq requirements. It has to ensure
that its accounts are in accordance with U.S.
GAAP
 For companies in developed countries, such
compliance leads to greater transparency, which
benefits the domestic shareholders
105
Advantages of Dual Listing
2. Foreign listings provide MNCs with indirect

advertising for their product brands
3. It raises the profile of the company in
international capital markets
 Makes it easier for them to borrow or raise debt
overseas
2. A spread of shareholders across the globe
reduces the threat of hostile takeovers.
106
GDRs and ADRs
Depository
 Foreign equity is Receipts
(DRs)
traded on
international markets
in the form of
Global American
Depository Depository Depository
Receipts. Receipts Receipts
(GDRs) (ADRs)
107
What is an ADR?
 A special share of foreign equity priced in U.S.D.

a. It is a DR issued to American investors on the basis of
shares issued by a foreign entity
b. Each receipt  represents ownership of a specific
number of securities
 These would have been placed with a custodian
bank in the issuer’s country
108
An ADR issue process
India India
Domestic Custodial
shares Bank
Wipro SBI
Depository
ADRs
Bank
USA USA
JP Morgan
Bank of New York
109
ADRs (cont…)
 ADRs can be packaged to ensure that they
trade at the appropriate price range in the U.S.
 ADRs can be a fraction/multiple of the
underlying foreign shares
110
Illustration
India USA
Domestic
ADRs USA
shares
1 ADRs =
Rs. 30 / share 60c /share 10 domestic
shares
$6 /share
111
Fungibility
 The ability to interchange with an identical item

One way fungibility Two way fungibility
The holder of an ADR can sell Shares can be surrendered to
the DR back to the depository the depository in the home
depository will in turn country and ADRs acquired in
have the equivalent lieu
number of shares sold in
the home market
Less attractive from the Required to ensure that there

standpoint of an American are no arbitrage opportunities
investor between the U.S and the
home market
Has potential to reduce
liquidity and the floating stock
112
Arbitrage
 How will arbitrage work in the case of

ADRs?
 Assume that the ADRs are overvalued in the
U.S.
 A trader in the U.S. can short sell ADRs in
the U.S.  acquire shares in India  have
USA
them converted to ADRsIndia
and cover his short
position in the U.S.
ADRs Domestic
shares
Overvalued Buy in India
hence shortsell Convert to ADRs
113
Arbitrageur – Infosys ADR overvalued
USA Exch rate Rs. 50/dollar India
1 ADR =
Domestic
10 domestic
shares
shares
$210 / ADR Rs.1000 /share
Shortsell 1 ADR(+$210) Acquire 10 shares (-Rs.10,000)

$200
Convert
Profit = $10
114
Arbitrage (Cont…)
 What if ADRs are undervalued in the U.S?
 An arbitrageur will buy ADRs in New York  surrender them
to the overseas depository bank in exchange for domestic
shares  and will then sell the domestic shares in India
USA India
ADRs Domestic
shares
Undervalued
Sell in India
hence buy
Convert to domestic shares

115
Arbitrageur – Infosys ADR undervalued
USA Exch rate Rs. 50/dollar India
1 ADR =
Domestic
10 domestic
shares
shares
$190 / ADR Rs.1000 /share
Buy 1 ADR(-$190) Sell 10 shares (+Rs.10,000)

$200
Convert
Profit = $10
116
ADRs - History
 First ADR was created by J.P. Morgan in 1927

 From the standpoints of clearing and settlement:
 ADR a domestic U.S security

 Traded on NYSE, AMEX, Nasdaq, and OTC markets
 1996: $13,655 billion worth of DRs were raised through 80 public

offerings by companies from 80 countries.
117
ADRs (Cont…)
 Four levels of ADRs in the U.S.

 They differ with respect to the amount of
information that is required to be provided
to the investors.
 This therefore has implications for the level
of access granted to the U.S. capital market.

118
Levels of ADRs
Levels of
ADRs
Unsponsored Sponsored Sponsored Sponsored

ADRs Level-1 ADRs Level-2 ADRs Level-3 ADRs
119
Levels of ADRs

ADRs Level-I ADRs Level-II ADRs Level-III
ADRs
Issued by Do not require Require Require even
depositories in compliance financial more
the U.S in with U.S. statements paperwork
response to GAAP, or conforming to
market disclosure U.S. GAAP,
demand beyond what and disclosure
is required in in accordance
the home with SEC
country regulations
120
Levels of ADRs

ADRs Level-I ADRs Level-II ADRs Level-III
ADRs
Issues are not Can be traded Can be traded Allow issuance
initiated by on OTC mkts on U.S. and sale of
the parent in the U.S. and exchanges new shares to
foreign on some raise equity
company exchanges capital in the
outside the U.S.
U.S
121
Benefits to Issuers
1. Company’s image is boosted at home and

abroad
2. Stock prices are brought in alignment with
international trends
3. Useful mechanism for raising capital in
foreign exchange
4. Issuer does not bear the risk of exchange
rate fluctuations
 since dividends are paid to the domestic
custodian bank in domestic currency
122
Benefits to Holders
1. Get access to assets which are quoted
in USD and trade like any U.S. security
2. Get dividends in USD
123

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Part-03

Equity shares  Shares of common stock of a

• asset for the shareholder • liability for the

 Shareholder is part owner of company

 Dividends are not contractually

• Shareholders cannot • The company is

 Dividends can fluctuate substantially

 It is not essential for a firm to have a profit in

 Reserves and Surplus account =

 y(profit) = Retained Earnings

 Equity shares never mature

1. Equity shareholders have voting rights.

 Most equity shares carry voting rights

 Common arrangement is 1 vote per

 To be eligible to vote, the shareholder

must be the Owner of Record

 Name must be present in the register of

shareholders on the prescribed Record

 Is usually a few days prior to ‘date of

the meeting’ of shareholders or ‘date of

actual voting’ takes place

 Person whose name figures in the register

 Why are proxies allowed?

 In practice managers solicit proxies from

 Equity shares have a Par Value also

known as the Face Value / Stated Value

 In some states in the U.S., the

incorporation fees for the firm are a

function of the par value of the shares

minimize these expenses

 Book value is the value of the assets behind a

 Book value may differ substantially from the

 Companies sometimes issue different

different voting rights on different

 Ford Motor Company has 2 classes of shares

 Class B shares are owned by the Ford family

 For many years the NYSE did not

 In the context of a dividend payment,

1. The Declaration Date

2. The Record Date

3. The Ex-dividend Date

4. The Distribution Date

 The date on which the decision to pay a

dividend is ‘declared’ by the directors

and the amount of the dividend is

 The dividend announcement will

 This is specified by the exchange on

Prior to the  The shares will be traded cum-

On the ex-  The shares will begin to trade ex-

In theory  On the ex-dividend date the share

In practice  The price decline may not be exactly

 This is the date on which the dividends

 These are called Bonus Shares in India.

stock rather than in cash

 Entails the issue of additional shares

 This is called the Capitalization of

 From a theoretical standpoint, stock

dividends do not create any value for

The issue of additional shares should lead to

In  The ex-bonus price may not fall

practice The market may interpret the bonus issue as

a signal of enhanced future profitability. 45