Common Stocks 

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Common Stocks



Investment Snapshot

* The bankruptcies of WorldCom and Enron resulted in shareholders losing their entire investments.
* Shareholders of Home Depot were irate at the $123.7 million pay package (excluding stock options) of CEO Bob Nardelli over a five-year period when Home Depot’s stock price declined by 9 percent for the same period. Rival Lowe’s stock price increased by 185 percent during that same period.

CHARACTERISTICS OF COMMON STOCK

* Common stockholders are the residual owners of the corporation because they have voting rights and bear the ultimate risk associated with ownership.
* In bankruptcy, common stockholders are last in line (after bondholders and preferred stockholders) for claims on assets.
* Shareholders’ liability is limited to the amount of their investments (limited liability).
* With regard to claims on earnings, common stockholders are entitled to receipt of dividends only after all the corporation’s obligations have been met.
* Shareholders receive dividends only when a company’s board of directors declares a dividend.

When a new company is formed, common stock is sold to shareholders to raise money for the company. Companies that need additional funds to expand sell more common stock, bonds, and/or preferred stock.

Ownership of common stock is evidenced by stock certificates. The front of a certificate shows the name of the issuing company, the name of the owner of the shares, the number of shares of ownership, the identifying serial number, the name of the register, and the par value of the stock. The back of a stock certificate normally includes an assignment statement, which must be signed by the holder of the stock when the holder transfers ownership of the shares.

Voting Rights

Voting rights are the rights of shareholders to vote. A characteristic of common stock is that shareholders can vote on important issues facing the corporation, such as membership to the board of directors. The board of directors, in turn, selects officers to run the corporation. Common shareholders must approve of any changes to the charter of incorporation. A charter of incorporation is a document that the company files with the state when forming a corporation. For example, a corporation’s management team that would like to take over another corporation through the issuance of new common shares would have to get approval from their shareholders.

Rather than attend the shareholders’ meeting to vote in person, many shareholders use a proxy vote. A proxy is a legal document that gives a designated person temporary power of attorney to vote at the shareholder meeting for an absentee shareholder. Most often management chooses both the slate of candidates to stand for the board of directors and the important issues to be voted on by shareholders. The names of these choices are then sent out on proxy cards to be voted on by shareholders.

Corporations use either the majority voting procedure (also known as the statutory method) or the cumulative voting procedure. In the majority voting procedure, shareholders are allowed one vote for each share held for each director’s position. Under the majority voting procedure, the number of votes a shareholder has equals the number of shares he or she holds. The majority of votes cast determines the issue or the director elected.

In the cumulative voting procedure, shareholders are entitled to a total number of votes equal to the total number of shares owned multiplied by the number of directors being elected. Shareholders can cast all their votes for a single candidate or split them as they see fit. Cumulative voting gives increased weight to minority shareholders, enabling them to elect at least one director. The following example illustrates the difference between majority voting and cumulative voting. Assume that a company has 1,000 shares outstanding and that two candidates are to be elected to the board of directors. Under majority voting, a minority shareholder with 300 shares, for example, can cast 300 votes for each of the two candidates. However, under cumulative voting, a minority shareholder with 300 shares could cast all 600 votes (300 * 2) for one candidate. This method is advantageous for minority shareholders because they can work together to cast all their votes for one candidate who might be more sympathetic to their cause.

Preemptive Rights

Preemptive rights allow shareholders to maintain their constant percentage of a company’s outstanding stock by being given the first chance to purchase newly issued stock in proportion to their existing percentage ownership of stock. Not all corporations provide preemptive rights in their charters. For example, if a shareholder owns 10 percent of a company’s stock, that shareholder is entitled to purchase 10 percent of new shares being offered. To put it another way, existing shareholders have the first right of refusal in purchasing new shares. Certificates called rights are issued to the shareholders, giving them the option to purchase a stated number of new shares at a specific price during a specific period. These rights can be exercised (which allows the purchase of new common stock at below-market price), sold, or allowed to expire.




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