Rules and Rights of Common and Preferred Stock

Claim to Income

In the cases of bankruptcy and dividend distribution, preferred stock shareholders will receive assets before common stock shareholders.

Preferred and common stock have varying claims to income, which will change from one equity issuer to another. In general, preferred stock will be given some preference in assets to common assets in the case of company liquidation. Still, both will fall behind bondholders when asset distribution takes place.

In the event of bankruptcy, common stock investors receive any remaining funds after bondholders, creditors (including employees), and preferred stockholders are paid. As such, these investors often receive nothing after a bankruptcy. Preferred stock also has the first right to receive dividends. In general, common stock shareholders will not receive dividends until they are paid out to preferred shareholders. Access to dividends and other rights varies from firm to firm.

1903 stock certificate of the Baltimore and Ohio Railroad Preferred and common stock both carry rights of ownership, but represent different classes of equity ownership.

Preferred stock may or may not have a fixed liquidation value (or par value) associated with it. This represents the amount of capital that was contributed to the corporation when the shares were first issued. Preferred stock has a claim on liquidation proceeds of a stock corporation equal to its par (or liquidation) value, unless otherwise negotiated. This claim is senior to that of common stock, which has only a residual claim.

Both types of stock can have a claim to income in the form of capital appreciation as well. As company value increases based on market determinants, the value of equity held in this company also will increase. This translates to a return on investment to shareholders. This will be different to common stock shareholders and preferred stock shareholders because of the different prices and rewards based on holding these different kinds of shares. In turn, should market forces decrease, the value of equity held will decrease as well, reflecting a loss on investment and, therefore, a decrease on the value of any claims to income for shareholders.

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Voting Rights

Common stock can also be referred to as a "voting share." Common stock usually carries with it the right to vote on business entity matters, such as electing the board of directors, establishing corporate objectives and policy, and stock splits. However, common stock can be broken into voting and non-voting classes. While having superior rights to dividends and assets over common stock, generally, preferred stock does not carry voting rights.

The matters that a stockholder gets to vote on vary from company to company. In many cases, the shareholder will be able to vote for members of a company's board of directors, and, in general, each share gets a vote as opposed to each shareholder. Therefore, a single investor who owns 300 shares will have more say in a voting matter than a single shareholder who owns 30.

Exercising Voting Rights

Many shareholders' voting rights can be exercised at annual general body meetings of companies. An annual general meeting is a meeting that official bodies and associations involving the general public (including companies with shareholders) are often required by law (or the constitution, charter, by-laws, etc., governing the body) to hold.

An AGM is held every year to elect the board of directors and inform their members of previous and future activities. It is an opportunity for the shareholders and partners to receive copies of the company's accounts, as well as to review fiscal information for the past year and ask any questions regarding the directions the business will take in the future. Shareholders also have the option to mail their votes in if they cannot attend the shareholder meetings.

In 2007, the Securities and Exchange Commission voted to require all public companies to make their annual meeting materials available online. Shareholders with the right to vote will have numerous options in how to make their voice heard with regard to voting matters should they choose to.

Shareholder Meeting This scene from "The Office" humorously illustrates a shareholder meeting, where the shareholder can exercise their right to vote on company issues or question company directors.

Purchasing New Shares

New share purchases are important actions by share shareholders since they require further investment in a business entity and reflect a shareholder's decision to maintain an ownership position in a company or a potential investor's belief that purchasing equity in a company will be an investment that grows in value.

Current shareholders may have preemptive rights over new shares offered by the company. In practice, the most common form of preemption right is the right of existing shareholders to acquire new shares issued by a company in a rights issue, a usually but not always public offering. In this context, the pre-emptive right is also called "subscription right" or "subscription privilege." This is the right, but not the obligation, of existing shareholders to buy the new shares before they are offered to the public. In this way, existing shareholders can maintain proportional ownership of the company, preventing stock dilution.

New shares may be purchased over the same exchange mechanisms that the previous stock was acquired. A stock exchange is a form of exchange that provides services for stock brokers and traders to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for the issue and redemption of securities and other financial instruments and capital events, including the payment of income and dividends. The initial offering of stocks and bonds to investors is, by definition, done in the primary market, and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets are driven by various factors that, as in all free markets, affect the price of stocks.

Exchanges New shares can be traded on exchanges such as the Nasdaq, but will usually be offered to current shareholders before being put on sale to the general public.

Preferred Stock Rules and Rights

Preferred stock usually has no voting rights but may carry a dividend and may have priority over common stock in the payment of dividends and upon liquidation. The terms of the preferred stock are stated in a "Certificate of Designation."

VOC stock Preferred stock is a security ( a little more modern than this stock from the VOC or Dutch East India Company) that carries certain rights that designate it from common stock or debt.

Preferred stock is a special class of shares that may have any combination of features not possessed by common stock. The following features are usually associated with preferred stock: Preference in dividends, preference in assets, in the event of liquidation, convertibility to common stock, callability, and at the option of the corporation.

Some preferred shares have special voting rights to approve extraordinary events (such as the issuance of new shares or approval of the acquisition of a company) or to elect directors, but, once again, most preferred shares have no voting rights associated with them. Some preferred shares gain voting rights when the preferred dividends are in arrears for a substantial time.

Preferred stock may or may not have a fixed liquidation value (or par value) associated with it. This represents the amount of capital that was contributed to the corporation when the shares were first issued. Preferred stock has a claim on liquidation proceeds of a stock corporation equal to its par (or liquidation) value unless otherwise negotiated.

This claim is senior to that of common stock, which has only a residual claim. Almost all preferred shares have a negotiated, fixed-dividend amount. The dividend is usually specified as a percentage of the par value or as a fixed amount. Sometimes, dividends on preferred shares may be negotiated as floating; they may change according to a benchmark interest-rate index. Preferred stock may also have rights to cumulative dividends.

Provisions of Preferred Stock

Preferred stock may be entitled to numerous rights, depending on what the issuer designates. One of these rights may be the right to cumulative dividends. Preferred stock shareholders already have rights to dividends before common stock shareholders. However, cumulative preferred shares contain the provision that should a company fail to pay out dividends at any time at the stated rate, then the issuer will have to make up for it as time goes on.

Historical dividend information for Franklin Automobile Company Dividends is one of the privileges of stock ownership, and preferred shares get more rights than common shares do.

Convertible preferred stock can be exchanged for a predetermined number of company common stock shares. Generally, this can occur at the investor's discretion, and he or she may pick any time to do so and, therefore, take advantage of fluctuations in the price of common stock. Once converted, the common stock cannot be converted back to preferred status.

Often, companies retain the right to call or buy back preferred shares at a predetermined price. These are callable shares.

There is a class of preferred shares known as "participating preferred stock." These preferred issues allow holders to receive extra dividends if the company achieves predetermined financial goals. Investors who purchase these stocks receive their regular dividend regardless of company performance (assuming the company does well enough to make its annual dividend payments). If the company achieves predetermined sales, earnings, or profitability goals, the investors receive an additional dividend.

Almost all preferred shares have a negotiated, fixed dividend amount. The dividend is usually specified as a percentage of the par value or as a fixed amount. Sometimes, dividends on preferred shares may be negotiated as floating; they may change according to a benchmark interest-rate index or floating rate. An example of this would be tying the dividend rate to LIBOR.

Comparing Common Stock, Preferred Stock, and Debt

Equity

Common Stock and Preferred Stock are both methods of purchasing equity in a business entity. Common stock generally carries voting rights, while preferred shares generally do not.

Preferred shares act like a hybrid security, in between common stock and holding debt. Preferred stock can (depending on the issue) be converted to common stock and have access to accumulated dividends and multiple other rights. Preferred stock also has access to dividends and assets in the case of liquidation before common stock does.

However, both common and preferred stock fall behind debt holders regarding claims to assets of a business entity should bankruptcy occur. Common shareholders often do not receive assets after bankruptcy due to this principle. However, common stock shareholders can theoretically use their votes to affect company decision-making and direction in a way they believe will help the company avoid liquidation in the first place.

Debt

Debt can be "purchased" from a company through a bond.

A bond from the Dutch East India Company A bond is a financial security that represents a promise by a company or government to repay a certain amount, with interest, to the bondholder.

In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt security under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest and/or to repay the principal at a later date, termed maturity. Therefore, a bond is a form of loan or IOU: the holder of the bond is the lender (the creditor), the issuer of the bond is the borrower (the debtor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments or, in the case of government bonds, to finance current expenditures.

Bonds and stocks are securities, but the major difference is that (capital) stockholders have an equity stake in the company (i.e., they are owners). In contrast, bondholders have a creditor stake in the company (i.e., they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely.