Dividends
A corporation may issue two basic classes or types of capital stock—common and preferred. If a corporation issues only one class of stock, this stock is common stock. All of the stockholders enjoy equal rights. Common stock is usually the residual equity in the corporation, meaning that all other claims against the corporation rank ahead of the claims of the common stockholder. Preferred stock is a class of capital stock that carries certain features or rights not carried by common stock. Within the basic class of preferred stock, a company may have several specific classes of preferred stock, each with different dividend rates or other features.
Companies issue preferred stock in order to avoid the following:
- Using bonds with fixed interest charges that must be paid regardless of the amount of net income.
- Issuing so many additional shares of common stock that earnings per share are less in the current year than in prior years.
- Diluting the common stockholders' control of the corporation, since preferred stockholders usually have no voting rights.
Unlike common stock, which has no set maximum or minimum dividend, the dividend return on preferred stock is usually stated at an amount per share or as a percentage of par value. Therefore, the firm fixes the dividend per share.
1903 stock certificate of the Baltimore and Ohio Railroad
Ownership of shares is documented by the issuance of a stock certificate and represents the shareholder's rights with regards to the business entity.
Details on Common Stock
Common stock is a form of corporate equity ownership, a type of security. The terms "voting share" or "ordinary share" are also used in other parts of the world; common stock is primarily used in the United States. It is called "common" to distinguish it from preferred stock. If both types of stock exist, common stock holders cannot be paid dividends until all preferred stock dividends (including payments in arrears) are paid in full. In the event of bankruptcy, common stock investors receive any remaining funds after bondholders, creditors (including employees), and preferred stock holders are paid. As such, such investors often receive nothing after a bankruptcy. On the other hand, common shares on average perform better than preferred shares over time.
Common stock usually carries with it the right to vote on certain matters, such as electing the board of directors. However, a company can have both a "voting" and "non-voting" class of common stock. Holders of common stock are able to influence the corporation through votes on establishing corporate objectives and policy, stock splits, and electing the company's board of directors. Some holders of common stock also receive preemptive rights, which enable them to retain their proportional ownership in a company should it issue another stock offering. There is no fixed dividend paid out to common stock holders and so their returns are uncertain, contingent on earnings, company reinvestment, and efficiency of the market to value and sell stock. Additional benefits from common stock include earning dividends and capital appreciation.
Details on Preferred Stocks
Preferred stock (also called preferred shares, preference shares or simply preferreds) is an equity security with properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. Preferreds are senior (higher ranking) to common stock, but subordinate to bonds in terms of claim (or rights to stock holders' share of company assets). Preferred stock usually carries no voting rights, but may carry a dividend and may have priority over common stock upon liquidation, and in the payment of dividends. Terms of the preferred stock are stated in a "Certificate of Designation. "
Similar to bonds, preferred stocks are rated by the major credit-rating companies. The rating for preferreds is generally lower, since preferred dividends do not carry the same guarantees as interest payments from bonds, and because they are junior to all creditors.