Given below are two statements:
Assertion (A): Companies afraid of a takeover bid would prefer debt to equity.
Reason (R): A public issue of equity may reduce the managements’ holding in the company and make it vulnerable to takeover.
In the light of the above statements, choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both (A) and (R) are true and (R) is the correct explanation of (A).
Assertion (A): Companies afraid of a takeover bid would prefer debt to equity. — True. Lenders get interest and repayment, but no say in who controls the company. So a company that fears a takeover bid would raise debt rather than equity.
Reason (R): A public issue of equity may reduce the managements’ holding in the company and make it vulnerable to takeover. — True. Fresh equity shares go to outsiders. The management’s share of the holding falls, and an outsider may buy enough shares to take over.
Why R explains A?
R says that a public issue of equity cuts the management’s holding and opens the door to a takeover. Debt normally does not dilute control. So a company afraid of a takeover avoids new equity and turns to debt, because debt keeps its holding safe.
NCERT (2026-27 Edition): “(f) Control Considerations: Issues of more equity may lead to dilution of management’s control over the business. Debt financing has no such implication. Companies afraid of a takeover bid would prefer debt to equity.” “11. Control: Debt normally does not cause a dilution of control. A public issue of equity may reduce the managements’ holding in the company and make it vulnerable to takeover. This factor also influences the choice between debt and equity especially in companies in which the current holding of management is on a lower side.” |