If debt is cheaper than equity why do companies approach the equity markets?

Answer 1

Well in any organization there needs to be a mix of financing sources, so even though you will choose debt over equity, in some instances to satisfy some interest parties equity must be used. So there lies your answer. there is no text book answer. it is more practical.

The major reasons are:

• Though debt is cheaper it is more riskier. Because there is an obligation to pay back the interest on debt and debt amount irrespective of making profit or loss. But dividends to the equity shareholders will be distributed only if company makes profit.
• Raising huge capital is not possible only by going for debt.
• By going to equity not only firms raise huge amount of capital in a short period but also they can spread the risk of doing business.

• Equities are expensive because the expectation of shareholders is more as they are taking more risk.
• The market value of the equity rises if the business does well and has a robust future outlook. This leads to the promoter holding also multiplying in value though it is notional to a great extent. In times of need the promoter can sell part stake in the business by offloading 5-10% equity to raise cash. The same cant be said about debt.

Answer 2

A firm will not finance its entire funding requirement by way of debt because that will cost it its independence.