Common and Preferred Stock
Common stock represents an equity ownership in a corporation. Normally, common shareholders have voting rights—one vote for each share of stock that they own—and can vote for members of the board of directors. Common shareholders may also have a preemptive right, which means that they have the right to maintain their proportion of ownership in the corporation. For example, if a shareholder who has a preemptive right owns 5% of the common stock of a corporation and the corporation decides to issue additional shares to the public, this shareholder would have the first option to purchase 5% of any new shares issued.
Preferred stock is a class of stock that has some advantages over common stock:
- a preference in dividends: Dividends to preferred shareholders normally need to be paid prior to paying dividends to common shareholders.
- features similar to debt: (including the payment of a fixed dollar for dividends) Dividends are shown as a percent of par value.
- claim preferences: claims of preferred stockholders are given a preference for claims of common stockholders. In the case of a liquidation, preferred shareholders would have a preference to assets over common shareholders after all other claims against the corporation are fully satisfied.
- Cumulative Preferred Stock: a feature that permits the preferred shareholder to collect dividends that have not been paid in previous years. Cumulative Preferred Stock guarantees that the preferred shareholders will receive all the dividends that they have been entitled to receive for previous years before any dividends are paid to the common shareholders.
- callable shares: shares that are callable means that the company can buy back the preferred stock at par value after a certain date.
- convertible shares: shares that are convertible gives the purchaser a right to convert their preferred shares for a given number of shares of common stock.
Basic Terminology
Shares of stock can be authorized, issued, or outstanding:
- Authorized shares of stock represent the maximum number of shares that a corporation is legally allowed to sell. The number of shares authorized is stated in the corporation charter.
- Issued shares of stock are the shares that have been sold. These shares may or may not be held by the stockholders, since the corporation might buy back shares of its own stock. When a corporation buys back its own stock, the stock is called treasury stock. The accounting for treasury stock is explained later in this lesson.
- Outstanding shares of stock are shares that have been issued by the corporation and remain in the hands of the shareholders. None of these shares have been bought back by the corporation. When a company pays a cash dividend, it makes the dividend payment to those who own the outstanding shares.
The following terms are critical to understand:
- Par value is a stated monetary value that is assigned to a share of stock. Today, most shares of stock are issued with no par value or a very low par value.
- No par value stock is stock that is issued without having a par value assigned.
- Stated value stock is a form of no par value stock that has been assigned a stated value instead of a par value for accounting purposes.
- Paid-in Capital (or contributed capital): The investment of the owners in the company. Contributed capital may include the following components:
- common stock;
- paid-in Capital in Excess of Par, common stock: This is the premium that was paid for the purchase of stock. This account exists only if there is a par value or stated value;
- preferred stock; and
- paid-in Capital in Excess of Par, preferred stock: This is the premium that was paid for the purchase of stock. This account exists only if there is a par value or stated value.
