Equity financing, why is it favoured by public companies?

There are many ways a company can raise capital for projects or any other requirements but why do public companies favour equity financing? They can float on the stock market issuing bonds and shares, they can take on long-term or short-term debt, or they can dip into their retained earnings/profit (if they have any!).
There are issues involving risk and return with raising capital which I would like to discuss.


With equity finance, the shareholder bares the risk. The company is under no obligation to repay any of the capital to the investors through dividends or any other means. Sounds ideal, and you may be thinking that's too good to be true, and it is!
Take the example of Martin J. Sullivan at AIG, America's largest insurance company, who was pressured out of the company by a group of high-profile investors. The investors were not happy after the company slumped and compared Sullivan to his predecessor and felt he should be replaced. The pressure from these investors instigated an emergency meeting from AIG's board of directors and shortly afterwards the announcement of Martin J. Sullivan's departure from the company was announced. Sullivan was begrudged by this an argued that he had to face everything apart from "a swarm of locusts". Sullivan is not the only one to be pressured out of a company by investors and this example demonstrates the power investors have. So, although there are no legal obligations to pay dividends or to act on behalf the shareholder's, if you do otherwise, you won't last long!


So, what other options do firms have?


Financing through debt is another option be it short-term or long term. These involve bonds, loans and other forms. What is evident in debt-financing, the lender will receive interest on top of repayment of the initial loan. Relatively speaking, this usually works out cheaper than equity finance because the amount paid in interest by a firm is less than what is paid out in dividends. If we consider what GlaxoSmithKline paid in interest and dividends for 2012 this will be reflected. The interest they paid was £779m and the dividends they paid was £3,814m. However, following the concept of risk and return, the risk associated with debt financing is higher than equity financing, because the firm is contractually obligated to repay the debt financing.


Taking these factors into consideration, which source of financing is best for a firm? The answer to that is quite simple, a mixture of both but favouring equity finance. When shareholder's invest in a company, their aim is for the company to do well, which is generally the consensus amongst other parties involved in the company. Therefore, although shareholder's can put pressure on a company,  the goals of shareholders and the company usually align. Also, if the company has a downslide, or a bad year, they can usually negotiate with shareholders relatively easily to cope with what the company's experiencing. Negotiating with lenders or banks is usually much more difficult and can cause problems possibly leading to insolvency. The downside of equity financing is clearly the cost of dividends, this is why there should be a mix of equity finance and debt finance, to slightly reduce the cost.