MODULE BUSINESS FINANCE

CHAPTER 4
CORPORATE STOCK

Learning Objectives:
1. Define corporate stock and stock financing
2. Enumerate and explain the advantages of common stock
financing
3. Recall varieties of common stock
4. Differentiate Common Stock and Preferred Stock

Corporations issue stock to raise money for capital or

operating expenses, such as purchasing new equipment or buying
advertising. When an investor purchases a share of corporate stock,
he owns a fractional portion of that company.

Corporate stock is an equity security issued by a

corporation. It is an instrument that signifies an ownership
position, or equity, in a corporation, and represents a claim on its
proportionate share in the corporation's assets and profits.

Different Types of Stocks

There are two main types of stocks: common stock and preferred stock.
1. Common Stock

Common stock represents ownership in a company and a claim

(dividends) on a portion of profits. Investors get one vote per share to
elect the board members, who oversee the major decisions made by
management. Common stocks entail the most risk. If a company goes
bankrupt and liquidates, the common shareholders will not receive
money until the creditors, bondholders, and preferred shareholders are
paid.

Advantages Of Common Stock Financing

 Common stock is the source of permanent capital.

 Common stock does not legally obligate the firm to pay dividend.
 Common stock financing increases the borrowing capacity of the
company.
 Common stock is easily marketable than debt and preferred stock.
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Varieties of Common Stock

 Classified common stock;
 Deferred stock;
 Voting trust certificate;
 Guaranteed stock; and
 Debenture stock

Classified Common Stock. This can either be Class A and Class B.

Companies subject to the 60 percent minimum local equity rule simplify their
approach by assigning 60 percent of its common stock as Class A stockholders
that can be owned only by nationals. The remaining 40 percent are classified as
Class B and may be owned by foreigners.

Preferred Stock. This is a minor type of issue generally issued to founders,

promoters, or managers as bonus for their efforts in getting the corporation
started.

Voting Trust Certificate. These certificates are given to trustees of a

corporation to ensure that the voting power remains in certain hands for a
period of time.

Guaranteed Stocks. The payment of dividends is guaranteed by another

corporation. This happens when a corporation purchases or leases the property
of another.

Debenture Stock. Debentures are transferable. It is an unsecured financial

instrument in raising capital through borrowing.

2. Preferred Stock

Preferred shares investors are usually guaranteed a fixed

dividend forever. This is different than common stock, which has
variable dividends that are never guaranteed. In the event of liquidation
preferred shareholders are paid off before the common shareholder.
Preferred stock may also be callable, meaning that the company has
the option to purchase the shares from shareholders at anytime for any
reason.

Differences Between Common Stock and Preferred Stock

Two classes of corporate stock shares are fundamentally different:
common stock and preferred stock. Here are two basic differences:
 Preferred stockholders are promised (but not guaranteed) a certain
amount of cash dividends each year, but the corporation makes no
such promises to its common stockholders. Each year, the board of
directors must decide how much, if any, cash dividends to distribute to
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its common stockholders.

 Common stockholders have the most risk. A business that ends up in
deep financial trouble is obligated to pay off its liabilities first, and then
its preferred stockholders. By the time the common stockholders get
their turn, the business may have no money left
to pay them.

Neither of these points makes common stock seem too

attractive. But consider the following points:
 Preferred stock shares usually are promised a fixed (limited)
dividend per year and typically don’t have a claim to any profit
beyond the stated amount of dividends. (Some corporations
issue participating preferred stock, which gives the preferred
stockholders a contingent right to more than just their basic
amount of dividends.)
 Preferred stockholders generally don’t have voting rights,
unless they don’t receive dividends for one period or more. In
other words, preferred stock shareholders usually do not
participate in electing the corporation’s board of directors or
vote on other critical issues facing the corporation.

Common stock represents a bundle of rights and powers. They include:

 the right to receive dividend payments typically from earnings --

if authorized by the board of directors
 the power to sell the stock (liquidity rights) and realize capital
gains on public trading markets or in private transactions-- if
there are willing buyers
 the right to receive consideration in a merger or other
fundamental transaction -- if approved by the board and the
shareholders
 the right to vote to elect directors and to approve fundamental
transactions (mergers, sale of assets, amendments to articles,
dissolutions)
 the right to receive a proportionate distribution of assets on corporate
liquidation
-- if the board and shareholders approve a dissolution

Shareholders are often said to have a residual claim to the

income and assets of the business. Financially, they stand last in line
behind corporate creditors, such as bondholders, short-term lenders,
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banks, trade creditors. When a company is unable to pay its debts, and
the company is forced into bankruptcy, shareholders receive nothing.

There are other kinds of ownership interests. For example, preferred stock has a
prior and often fixed claim to dividends and distributions, but typically lacks the
power to elect directors or vote on fundamental corporate transactions. Often
seen as a hybrid between debt and common stock, preferred has characteristics
of both. Similar to debt, preferred stock offers a fixed dividend, but usually no
voting rights unless the company stops paying dividends. Similar to equity,
preferred has no maturity and the firm does not go bankrupt if it cannot pay
dividends.

Stock Financing

Stock financing is an activity undertaken by a firm when they

desire to raise funds for the long-term financing requirements of the
firm. The objective of stock financing is to increase equity capital. Stock
finance is a mechanism which releases working capital from stock such
as finished goods or raw materials, which works by lenders purchasing
stock from a seller on behalf of the buyer.

One of the biggest advantages of common stock from the

issuing company's perspective is the absence of required payments.
Debt financing requires a business to make interest and principal
payments on a specified schedule. Common stock has no such
requirements.

The advantages of using stock financing are:

 Common stock does not obligate the firm to make fixed

payments to stockholders,
 Common stock carries no fixed maturity date,
 Common stock increases the creditworthiness of the firm thus
increasing the future availability of debt at a lower cost,
 Common stock can often be sold more easily than debt if the
firm’s prospects look potentially good but risky, and
 Financing with common stock serves as a reserve of borrowing capacity.
The disadvantages of common stock financing to the corporation:

 Issuing common stock extends voting rights and perhaps even

control, to new stockholders,
 Common stock gives new stockholders the right to a
percentage of profits rather than to a fixed payment in the
case of creditors,
 The cost of underwriting and distributing common stock is high,
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 If common stock is sold to the point where the equity ratio

exceeds that in the optimal capital structure, a firm’s average
cost of capital will increase and its stock price will not be
maximized, and
 Dividends paid to stockholders are not tax deductible as is
interest paid to creditors.

For further discussion, please refer to the link provided: Types of a Corporate stock
https://www.youtube.com/watch?v=oVVt6P2q-6c
For further discussion, please refer to the link provided: Bond vs. Stock
https://www.youtube.com/watch?v=rs1md3e4aYU

REFERENCES:
Basic Business Finance: Management Approach, 2nd
Ed., BY: Ruby F. Alminar-Mutya