Why is equity considered more expensive than debt?

Equity is often considered more expensive than debt due to the higher risks that equity holders face. Unlike debt holders, who have a contractual right to receive interest payments and the return of their principal regardless of the company's performance, equity investors are only compensated through dividends and capital appreciation, which are not guaranteed.

Since equity holders are last in line to be paid in the event of liquidation, they bear the greatest risk in terms of potential loss. This means that investors typically demand a higher return for the risk they undertake when providing capital to a company in exchange for equity. In addition, the company's performance can directly impact their potential returns, making it a riskier investment choice compared to fixed-interest debt.

In contrast, debt financing often comes with set repayment schedules and priority status in bankruptcy proceedings, making it less risky for investors. As a result, the cost associated with issuing equity capital is generally higher than that of debt, reflecting the greater risks faced by equity investors in the financial structure of a company.