Reasons for Issuing Common and Preferred Stock

@font-face { font-family: “Cambria”; }p.MsoNormal, li.MsoNormal, div.MsoNormal { margin: 0in 0in 10pt; font-size: 12pt; font-family: “Times New Roman”; }div.Section1 { page: Section1; }

Common and preferred stock represent two forms of corporate shareholder equity. Financial managers must weigh the benefits for issuing varying combinations of common and preferred stock against each other to finance the corporation.  Investors should become familiar with the basics of corporate finance in order to appreciate the different criteria for issuing common and preferred stock.

The Corporation

The corporation is organized beneath the terms of state law as a legal entity, which is separate from that of its owners and management. “Limited liability” is the technical term for this separation.

Investors only stand to lose the amount of money that has been put into the business. Limited liability indicates that the outside and personal assets of ownership will be shielded from bankruptcy litigation related to the corporation. Limited liability enables corporations to finance themselves easily by selling ownership stakes to investors.

Corporate Finance

Corporations earn access capital by issuing debt to creditors and selling shares to the investing public. Debt must be repaid in full, with interest. Shares represent ownership, or equity in the company, and carry claims to assets and future earnings. Although shareholder equity is identified with ownership, creditors carry superior rights to property in the event of bankruptcy.

Share price values will fluctuate according to management decisions and economic factors that affect profits. Profits may be reinvested back into the company to grow the business further, and / or paid out to shareholders in the form of dividends.

Corporate financials are “balanced” by the assets equal liabilities plus shareholder equity equation. Shareholder equity is often divided into common and preferred shares of stock.

Common Stock Equity

One share of common stock equity represents one claim to the assets and income of the corporation. Common stock also carries voting rights. Owners use these voting rights to elect a board of directors that in turn, hires management to operate the company. Management decisions and earnings performance will influence the value of the common stock. Generally, common stock investors are more so concerned with capital appreciation, rather than dividend income payments.

Preferred Stock Equity

Eponymous preference shares carry qualities that are “preferred” to common stock. Preferred stock features claims that supersede common in terms of dividend payments and bankruptcy proceedings. Dividends must be paid first to preferred shares, prior to those upon common stock. Further, unpaid preferred stock dividends will accumulate until the corporation maintains the financial strength to make the payments.

Preferred shares typically carry fixed rate dividends that stretch into perpetuity. These regular dividend payments are attractive to investors in search of income.

Separate classes of preferred shares have been engineered to allow for greater flexibility. Convertible preferred shares are convertible into common stock and participating preferred shares adjust dividend payments upward to allow these shareholders to be rewarded with any increases in profitability.

Still, preferred shares lack the voting rights that are awarded to common stockholders.

Issuing Common Vs. Preferred Stock

Corporations must be aware of the advantages of both common and preferred shares, prior to issuing stock. Corporations seeking to raise capital, without ceding additional control will look to issue preferred stock. Meanwhile corporations that wish to secure equity financing, without the burden of promising dividend payments would be better served to issue common stock.

FacebookLinkedInEmailGoogle BookmarksShare

Comments are closed.

Custom Search
Subscribe by RSS
Subscribe by Email:
Delivered by FeedBurner