Common Stock

Equity securities can be of two general types: common stock and preferred stock. Common stock is used by all corporations, while only a few companies issue preferred stock.

what is common stock

Shareholders who own common stock are the residual owners of the company. Residual ownership of the company means that in the event the company is liquidated, the common shareholders will receive money only after all other creditors (including preferred shareholders, if any) have been paid in full.

The cost of common stock is generally the highest of the sources of financing because of the high level of risk that common shareholders take. While common shareholders are in a position to receive high returns when the company is successful, there are no guaranteed payments of interest like in a bond, and in the case of liquidation and the payment of dividends, common shares come after preferred shares.

As a result of their ownership of common stock, shareholders participate in the leadership and management of the company through their right to vote. The laws of the state where the company is incorporated and the registration statements of the shares themselves govern the characteristics of the common shares and shareholder rights. Therefore, it is not possible to list all of the possible characteristics of common shares.

However, most common shareholders have the following rights and expectations:

1. The right to vote. Different methods are used for voting, but almost all owners of common shares have the right to vote at the annual shareholders’ meeting. While votes are taken on a variety of corporate issues (such as mergers) the most significant vote is the election of a Board of Directors to oversee the company management on behalf of the shareholders. Shareholders that do not plan to attend the annual shareholders’ meeting can designate someone else as their proxy, such as a member of the company’s management, to vote their shares in line with their directions as written on the proxy forms they submit.
2. The right to receive dividends if common dividends are declared. Common dividends may or may not be declared in a given year. However, if they are declared, all common shareholders have the right to receive their dividend. Though shareholders are not guaranteed dividends, the right to receive dividends if they are declared is one of the rights of shareholders.
3. The right to buy shares of a new issue IF the shares have preemptive rights. If the company’s bylaws give preemptive rights to the shareholders, the existing shareholders have the right to purchase the same percentage of any newly issued shares as the percentage they own of the currently outstanding shares. Preemptive rights prevent the ownership share of existing shareholders from being automatically diluted because of the issuance of new shares. However, the preemptive right simply gives the existing shareholders the right to purchase the new shares. The holdings of any shareholder who chooses not to make the purchase will be diluted by the sale of the new shares.
4. The rights to share in the distribution of residual assets. As previously mentioned, if the company is liquidated, common shareholders will receive a distribution of whatever assets are left after all creditors have been paid in full .

Because shareholders are not guaranteed an annual return such as interest and they are usually the last ones to receive any distribution of assets in the event the company is liquidated, ownership of equity (shares) involves a certain amount of risk for the shareholders. However, the owners of shares are in position to benefit more from the success of the company than a bondholder would because there is no limit to the dividends or capital appreciation they may receive.