A company may issue debt to raise fund and pays interest based on cost of debt (YTM), and this costs company money. And I can see how debt costs company.

A company may issue stock to raise fund as well. Assume in hell, the company will never pay dividends, buy back shares, and so on, and shareholders can't force the company to do so. The share price can go up and down, and the poor shareholders can get back leftover in case of liquidation, fortunately. But the management, Lucifer and his fella, doesn't care about share price. Anything else is same as how companies on earth are like.

Therefore, as long as the company functions, shareholders can't get anything solid back from the evil company. The only way they can gain money is through share price appreciation.

My question is: in this case, does the COST OF EQUITY still make sense? Does the equity cost the COMPANY anything?

  • Jurisdiction matters when it comes to costs, especially regarding levies and taxes on what might otherwise be considered ‘free’. Try picking a jurisdiction that one can examine while still in mortal coil.
    – Lawrence
    Aug 22 '19 at 14:59
  • Given your scenario, I don't see how the price could ever go up (who would buy the shares on the secondary market). It would only go down, as the current holder finds someone willing to take it off his hands. Without any trades, the "price" wouldn't change at all. Unclear is also why anyone bought the initial offering in the first place (unless the company lied about dividends, etc. initially).
    – chepner
    Aug 22 '19 at 17:06
  • In your scenario, the company didn't sell stock; they sold stock certificates.
    – chepner
    Aug 22 '19 at 17:11
  • @Abel, Even in the real world, some companies have multiple share classes, with some classes not having voting rights. In order to entice people to buy non-voting shares, they have to offer something in return, usually higher dividends and higher priority for assets at liquidation.
    – The Photon
    Aug 22 '19 at 17:51

If a company is set up in such a way that it will never pay dividends or buy back shares, and the shareholders can’t force it to, then no one will buy any shares that it issues and so there will be no equity. This will obviously cost the company nothing, but on the other hand it won’t gain the company anything either.

  • 2
    The shares would not strictly be worthless though. They have value if: They are bought out by some other company, are merged with some other company which issues new shares to existing shareholders without these restrictions, or (unlikely) the company winds ups business while still having more assets than liabilities. Also unless these are non-voting shares, there is usually some non-zero value associated with the voting rights (although possibly rather small, and might be zero if some entity has a majority or super-majority of votes). Aug 22 '19 at 14:54
  • @KevinCathcart They can’t be bought by some other company, because these are special diabolical shares that only exist for the purpose of this question and don’t give the shareholders control of the company.
    – Mike Scott
    Aug 22 '19 at 15:01
  • @KevinCathcart I didn’t need to state it, because it’s in the question that I was answering. “... shareholders can't force the company to do so” means shareholders can’t control the company.
    – Mike Scott
    Aug 22 '19 at 16:14
  • You assume shareholders being unable to force the company to buy back shares or issue dividends, means they have no control of the company. Perhaps it has a charter that prohibits buybacks and dividends, and requires 100% votes to agree to any charter changes. Management owns 1+ share(s) w/ voting rights, and does not consent. Assuming local law allows this, then shareholders absolutely could have voting rights. And it makes the question interesting, as there is reason to buy shares, but still no obvious cost to the company itself (although management would suffer dilution of control). Aug 22 '19 at 17:09

Your forgetting about the liquidity of stocks and how price is controlled by perception.

Let's look at public markets as an example since they are the most liquid.

Stocks are freely traded on the open market and prices are determined by perception. Value is subjective.

This may seem irrational, but it's how the system works. Most investors are investing in the stock itself, meaning they want to see stock price appreciation (and owning a piece of the company is less of a consideration).

When someone buys a stock that doesn't pay dividends, they are betting on the future of the company. Take Amazon as an example. The stock price has more than tripled in the past decade because people are investing in the future of Amazon. In a way, it doesn't matter what the actual stock/ownership is worth as much as it matters that people think it's worth a certain price. I can't tell you how much money Amazon is worth, but I can tell you how much you can buy a share for.

Since shares are freely traded, investors can make money as the stock's price increases.

To answer your second question, offering equity DOES cost the company. We already discussed how public perception can impact the price of a stock. If a company issues unlimited shares, they will lose investors' faith, and the price could drop.

Furthermore, selling more equity has measurable impacts on stock price fluctuation. Stock prices fluctuate relative to supply and demand. When demand outweighs supply (i.e. more people want to buy than sell), the stock price goes up. If the company continues to issue new shares, they are increasing the supply and making it difficult for the stock price to increase. This is why investors and traders are always wary of secondary offerings.

This same logic applies to private funding, but there is lower liquidity since shares aren't traded on the open market.

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