Residual Claim to Income
The equity shareholders have a residual claim to the income of the company. They are entitled to the remaining income/profits of the company after all outside claims are met. The earnings/income available to the shareholders (EAS) equals profit after tax (PA), use preference dividend; the PAT is equal to operating (EBIT) less taxes. However, the residual claim is only a theoretical entitlement as the amount actually received by the shareholder, in the form of dividend will depend of the decision of the board of directors. The directors have the right to decide what portion of the (EAS) will be distributed to the shareholders as cash dividend and what portion will be back as retained earnings which the shareholders will receive later in the form of capital appreciation bonus shares. In other words, the payment of dividend depends on the discretion of management and shareholder have no legal right to receive the companions no legal obligation to distribute, dividends out of EAS. This is in sharp contrast to the claims of debenture-holders, which is a contractual obligation of the company must always he honored irrespective of its financial position.