What is Common Stock?

Common stock represents ownership shares in a corporation. Ownership gives common stockholders certain rights and privileges that bondholders do not have. Common shareholders can vote to select the corporation’s board of directors. 

The board of directors, in turn, exercises general control over the firm. In addition to voting for the board, common shareholders may vote on major issues facing the firm, such as corporate charter changes and mergers.

The common shareholders have a claim on all business profits that remain after the holders of all other classes of debt and equity securities have received their coupon payments or returns. But the firm may wish to retain some of those profits to reinvest in the firm to finance modernization, expansion, and growth. 

When so declared by the board of directors, owners of a firm’s common stock receive dividend payments. The dividend is typically a cash payment that allows shareholders to receive some income from their investment. To many investors, an attractive characteristic of common stock dividends is their potential to increase over time. 

As a firm achieves success, its profits should grow and the shareholders can expect to see the dollar amount of their dividends rise. Of course, success and growth are not guaranteed. A firm may experience poor earnings or losses, in which case shareholders bear the risk of smaller dividends or the elimination of dividend payments until the firm’s financial situation improves.

The common stockholders have the lowest standing when a business venture is liquidated or fails. All creditors, bondholders, and preferred stockholders must, as a rule, be paid in full before common stockholders receive proceeds from liquidation. 

As with dividends, all bankruptcy or liquidation proceeds remaining after prior obligations are settled accrue to the common stockholders, but it is rare when the proceeds of an asset sale from a bankrupt corporation fulfill the claims of creditors and preferred stockholders. 

Common stockholders generally receive little, if anything, from liquidation proceedings. The common stockholders, therefore, are affected hardest by business failure just as they enjoy the primary benefits of business success.

The common stock of a corporation may be assigned a par value (equity), or stated value, in the certificate of incorporation. Unlike bonds, the par value of common stock usually bears little relationship to the current price or book value of the stock. It is used mainly for accounting purposes and some legal needs.

Common stock may be divided into special groups, generally Class A and Class B, to permit the acquisition of additional capital without diluting the control of the business. When a corporation issues two classes of common stock, it will often give voting rights to only one class, generally Class B. Except for voting, owners of Class A stock will usually have most or all of the other rights and privileges of common stockholders. 

Issuing nonvoting equity securities is opposed by some government agencies, including the Securities and Exchange Commission (SEC) because it permits the concentration of ownership control. The New York Stock Exchange (NYSE) refuses to list the common stock of corporations that issue nonvoting classes of common stock.

At times, different stock classes are created following the acquisition of one corporation by another. For example, General Motors’ Class E shares and Class H shares were issued in the past to help finance GM’s acquisition of Electronic Data Systems (EDS) and Hughes Aircraft, respectively. The dividends on GM’s Class E and H shares were related to the earnings of their respective subsidiary.

American depository receipts (ADRs) represent shares of common stock that trade on a foreign stock exchange. The receipts can be traded on U.S. exchanges.

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