Common stock

Definition

Common stock represents ownership in a corporation and comes with voting rights, allowing shareholders to participate in key corporate decisions. It is one of the primary means by which companies raise capital through equity financing, giving investors a claim on a portion of the company’s profits through dividends and appreciation in share value. Common stockholders are last in line for asset distribution in the event of liquidation, making it a riskier but potentially more rewarding investment compared to other types of stock.

5 Must Know Facts For Your Next Test

1. Common stockholders have the right to vote on significant corporate matters, such as mergers or changes to the corporate structure.
2. When a company performs well, common stock can increase significantly in value, providing substantial returns to shareholders.
3. Common stock typically carries higher risk compared to preferred stock due to its position in the hierarchy for claims on assets.
4. In many cases, common stock dividends are not guaranteed and depend on the company’s profitability and board decisions.
5. The total number of outstanding common shares directly affects the company's market capitalization and is crucial for evaluating its overall market value.

Review Questions

• How does common stock provide value to investors compared to other forms of equity?
  • Common stock offers investors the potential for capital appreciation as the company's value increases, along with voting rights that give them a say in corporate governance. Unlike preferred stock, common stock dividends are not fixed and may vary based on company performance, providing a higher risk-reward scenario. Investors can benefit from significant gains if the company performs well, making common stock an attractive option despite its inherent risks.
• Discuss the implications of issuing new common stock for existing shareholders and the overall company valuation.
  • Issuing new common stock can dilute the ownership percentage of existing shareholders, potentially impacting their voting power and earnings per share. This dilution occurs because there are now more shares outstanding while profits remain constant, which may lead to a lower valuation per share. However, if the capital raised through this issuance is effectively utilized for growth opportunities, it could enhance overall company performance and ultimately benefit all shareholders in the long run.
• Evaluate the role of common stock in a company's capital structure and its influence on financial decision-making.
  • Common stock plays a crucial role in a company's capital structure as it represents equity financing that does not need to be repaid like debt. This equity cushion can provide financial stability and flexibility for future investments or expansions. However, management must carefully consider how much common stock to issue versus relying on debt financing since too much equity can dilute ownership and affect control over the firm while too much debt can increase financial risk. Striking the right balance is essential for sustainable growth and maximizing shareholder value.

Related terms

dividends: Payments made by a corporation to its shareholders, typically derived from profits, as a reward for their investment.

preferred stock: A class of stock that has priority over common stock in terms of dividends and asset distribution during liquidation, but usually does not carry voting rights.

equity financing: The method of raising capital by selling shares of a company, which can include common and preferred stock.