Common stock

Definition

Common stock is a type of equity security that represents ownership in a corporation, providing shareholders with voting rights and the potential for dividends. This form of stock is crucial as it determines the economic interest of shareholders in a company, impacting their participation in decisions and their share of profits. It's often included in financing agreements and is a key component when negotiating term sheets.

5 Must Know Facts For Your Next Test

1. Common stockholders have the right to vote on important company matters, such as electing the board of directors and approving major corporate actions.
2. The value of common stock can fluctuate based on market conditions, company performance, and investor sentiment, impacting the overall market capitalization of the company.
3. In the event of liquidation, common stockholders are last in line to receive any remaining assets after creditors and preferred stockholders have been paid.
4. Dividends paid to common stockholders are not guaranteed and can be suspended or reduced based on the company's financial performance and strategic decisions.
5. Common stock is often used as a mechanism for employee compensation through stock options, aligning employee interests with those of shareholders.

Review Questions

• How does common stock impact shareholder voting rights and decision-making within a company?
  • Common stock grants shareholders voting rights, allowing them to influence key decisions within the company, such as electing board members and approving mergers or acquisitions. This participatory role is essential for shareholders as it aligns their interests with the company's strategic direction. The ability to vote empowers common stockholders to express their preferences and hold management accountable for their performance.
• Discuss the differences between common stock and preferred stock in terms of dividends and liquidation preferences.
  • Common stockholders may receive dividends that are not fixed and are contingent on the company's profitability, while preferred stockholders typically receive fixed dividends that must be paid before any dividends are distributed to common shareholders. In terms of liquidation, common stockholders are last in line to be compensated after creditors and preferred stockholders have been settled. This creates a hierarchy in terms of risk and return between these two types of equity securities.
• Evaluate how the issuance of common stock can affect a company's capital structure and investor perception.
  • Issuing common stock can significantly impact a company's capital structure by increasing equity financing, which can reduce reliance on debt and improve financial stability. However, it can also dilute existing shareholders' ownership percentages, potentially leading to negative perceptions among investors if they feel their control over the company is diminishing. The decision to issue common stock should carefully balance the need for capital with maintaining investor confidence and ensuring sustainable growth.

Related terms

preferred stock: A type of equity security that has a higher claim on assets and earnings than common stock, typically offering fixed dividends but no voting rights.

equity financing: The method of raising capital by selling shares of the company, allowing investors to gain ownership stakes in exchange for their investment.

dividends: Payments made by a corporation to its shareholders, usually derived from profits, which can be distributed in cash or additional shares.