Common stock

Definition

Common stock is a type of equity security that represents ownership in a corporation, granting shareholders voting rights and the potential to receive dividends. Holders of common stock are typically entitled to vote on company matters, such as the election of the board of directors, and share in the profits through dividends and capital appreciation. It plays a crucial role in equity distribution by determining the ownership structure and financial stake of shareholders in a company.

5 Must Know Facts For Your Next Test

1. Common stockholders are last in line when it comes to claims on assets during liquidation, meaning they may not recover their investment if a company goes bankrupt.
2. The value of common stock can fluctuate widely based on company performance, market conditions, and investor sentiment.
3. Companies can choose to pay dividends on common stock, but they are not required to do so, making them riskier than preferred stocks that usually guarantee dividends.
4. Voting rights associated with common stock allow shareholders to influence corporate decisions and policies, often directly impacting the direction of the company.
5. Ownership of common stock can lead to capital gains if the value of the stock increases over time, allowing shareholders to sell their shares for more than they paid.

Review Questions

• How does owning common stock affect a shareholder's rights and influence within a company?
  • Owning common stock gives shareholders voting rights that allow them to participate in key decisions, such as electing the board of directors or approving major corporate changes. This influence is significant because it empowers shareholders to voice their opinions on how the company is run. However, it’s important to remember that while they have a say, their voting power is proportionate to the number of shares they own, which can lead to a disparity in influence among shareholders.
• Discuss the risks and rewards associated with investing in common stock compared to preferred stock.
  • Investing in common stock carries both risks and rewards. Common stockholders have the potential for higher returns through capital appreciation and dividends when a company performs well. However, they also face greater risks since they are last in line during asset liquidation and may not receive any dividends if a company struggles financially. In contrast, preferred stockholders enjoy fixed dividends and priority over assets during liquidation but typically lack voting rights, making common stock potentially more rewarding but riskier overall.
• Evaluate the impact of market conditions on the valuation of common stock and how this relates to investor behavior.
  • Market conditions significantly affect the valuation of common stock, as prices can be driven up or down by various factors such as economic indicators, interest rates, or geopolitical events. Investor behavior often reacts to these conditions; for example, bullish markets may lead investors to purchase more stocks anticipating higher returns, while bearish markets might cause them to sell off shares out of fear. This interplay between market conditions and investor sentiment is crucial for understanding fluctuations in common stock prices and overall market dynamics.

Related terms

dividends: Payments made by a corporation to its shareholders, typically out of profits, as a return on their investment.

preferred stock:

A type of equity security that has a higher claim on assets and earnings than common stock, often providing fixed dividends and no voting rights.

market capitalization: The total market value of a company's outstanding shares of common stock, calculated by multiplying the share price by the total number of outstanding shares.