Common stock is a type of equity investment that represents a partial ownership in a corporation. It entitles the shareholder to certain rights and privileges that are different from those enjoyed by holders of preferred stock, according to accountant Larry Walther at the School of Accountancy, Utah State University. However, the corporation also enjoys certain advantages at the expense of shareholders.
Advantages to Corporation
When a corporation issues common stock, it increases its borrowing power. At the same time, it does not have to repay what shareholders invest, nor is it obliged to pay any dividends to them. This allows the corporation to reinvest its earnings for business needs. Another major advantage is that in the event of bankruptcy, the corporation does not have to pay holders of common stock until it settles all other claims.
Advantages to Shareholders
Generally speaking, common stock does not place many constraints on the corporation, according to Professor of Finance Hans Isakson at the University of Northern Iowa. However, shareholders are typically allowed one vote per share in electing the corporation's board of directors and can also cast votes regarding certain other issues, like stock splits. So by issuing common stock, the corporation must share some of its earnings as well as control of management.
Classes of Common Stock
A corporation will sometimes offer different classes of common stock that trade publicly at different prices and pay different dividends, according to the Financial Industry Regulatory Authority. Each class may also have different voting rights, or no voting rights at all. However, when a corporation offers two classes of common stock, one is usually publicly traded and the other is reserved for the founders or owners of the company, who maintain control of it.
When the profits of a corporation decrease, holders of common stock bear the brunt of losses when share prices drop. while the prices of preferred stock are less volatile. Although both types of stock represent partial ownership in the corporation, holders of preferred stock have a dominant claim on the assets of the business, are usually guaranteed a fixed dividend, unlike holders of common stock. If liquidated, the corporation pays the holders of common stock only if there are any assets remaining after other creditors are paid.
- "Principles of Accounting"; Larry Walther; 2010
- Financial Industry Regulatory Authority: Stocks
- Common Stock and Dividend Policy; Advantages and Disadvantages of Common Stock; Hans Isakson
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