BUS103: Introduction to Financial Accounting

A corporation may issue two basic classes or types of capital stock – common and preferred.

If a corporation issues only one class of stock, this stock is common stock. All of the stockholders enjoy equal rights. Common stock is usually the residual equity in the corporation. This term means that all other claims against the corporation rank ahead of the claims of the common stockholder.

Preferred stock is a class of capital stock that carries certain features or rights not carried by common stock. Within the basic class of preferred stock, a company may have several specific classes of preferred stock, each with different dividend rates or other features.

Companies issue preferred stock to avoid: (1) using bonds with fixed interest charges that must be paid regardless of the amount of net income; (2) issuing so many additional shares of common stock that earnings per share are less in the current year than in prior years; and (3) diluting the common stockholders' control of the corporation, since preferred stockholders usually have no voting rights.

Unlike common stock, which has no set maximum or minimum dividend, the dividend return on preferred stock is usually stated at an amount per share or as a percentage of par value. Therefore, the firm fixes the dividend per share. Exhibit 20 shows the various classes and combinations of capital stock outstanding for a sample of 600 companies.

Exhibit 20: Capital structures