Financial Markets 10 - Chapter 10 Equity Markets I Common...

Chapter 10- Equity Markets
I. Common Stock : equity securities that have no special dividend rights and have the
lowest priority claim in the event of bankruptcy
• Common stock represents the basic ownership claim in a corporation
• Most prevalent type of equity security
- Residual claim : (most distinguishing feature) a claim against a firm’s cash flow or
assets; in the event of the firm’s liquidation, those with prior claims (ex: claims of
employees, the government, short-term creditors, bondholders, and preferred
stockholders) are paid first and the common stockholders are entitled to what is left
over, the residual
- Limited liability of stockholders: meaning that their losses are limited to the
original amount of their investment. Limited liability also implies that the personal
assets of a shareholder cannot be obtained to satisfy the obligations of the corporation.
(the opposite of this, a sole proprietor is personally liable for the firm’s obligations)
- Dividends : corporate payments to shareholders. Common stock dividends are not
guaranteed, and a corporation does not default if it does not pay them.
• Dividends are paid out of the firm’s after-tax cash flow. Because dividend income is
taxable for most investors, corporate profits are doubly taxed—once when the
corporation pays the corporate income tax, and once more when the investors pay their
personal income taxes.
• To avoid double taxation, some investors hold stocks in growing companies that
reinvest their accumulated earnings instead of paying larger dividends. Reinvestment
of earnings allows the company to accumulate capital and grow faster than it
otherwise might.
- Voting rights and proxies
Although stockholders own the corporation, they do not exercise control over
the firm’s day-to-day activities. Control of the firm is in the hands of the corporate
managers who are supposed to act in the interest of the shareholders. Shareholders
exercise control through the election of a board of directors. It is the task of the board
of directors to monitor the managers’ activities on behalf of the shareholders.
Shareholders elect directors by casting votes at an annual meeting. Most shareholders
do not actually attend the meeting, voting instead by proxy , a process in which
shareholders vote by absentee ballot.
- Dual-class firms
One vote is attached to each share of stock, although there are exceptions,
called dual-class firms . Which are firms that recapitalize with two classes of stock
having different voting rights
• Two procedures for electing directors:

o cumulative voting : all directors are elected at the same time and shareholders are
granted a number of votes equal to the number of directors being elected times the
number of shares owned
 allows minority shareholders a voice in the firm’s decisions
o straight voting : directors are elected one by one.