15.1 Some features of common and preferred stocks

15.1 Some Features of Common and Preferred Stocks

Introduction

• Focus on the features of stocks and bonds, specifically common and preferred stocks.

Common Stock Features

• Definition: Common stock has no special preference in dividends or bankruptcy.

Shareholder Rights

• Shareholders elect directors who manage the corporation.

• Voting rights: "one share, one vote" principle.

• Directors are elected annually at shareholder meetings.

• Voting procedures: cumulative vs. straight voting.

  • Cumulative Voting: Allows minority participation; total votes = shares owned multiplied by the number of directors to be elected.

    • Example: Smith (20 shares) and Jones (80 shares) voting for 4 directors enables Smith to guarantee a seat using 2,501 shares.

  • Straight Voting: Directors elected one at a time; majority shareholders can dominate elections, potentially excluding minority shareholders.

Effects of Voting Procedures

• Cumulative voting gives power to minority shareholders.

• Mandatory cumulative voting exists in some states to protect minority interests.

• Staggered Elections: Only a fraction of directors are elected at one time, complicating minority voting.

Proxy Voting

• Shareholders can vote in person or grant a proxy to someone else, leading to proxy fights to replace management.

Classes of Stock

• Corporations may issue classes of common stock with unequal voting rights.

  • Example: Ford's Class B stock has higher voting power but limited public trading.

• Alphabet's Class A shares have 1 vote, while Class B shares have 10 votes.

• Issues can arise with dual classes of stock in maintaining management control.

Other Rights of Shareholders

• Rights include:

  1. Proportional dividends.

  2. Share in assets upon liquidation.

  3. Vote on significant corporate matters (e.g., mergers).

  4. Preemptive rights to purchase additional shares before public offers.

Dividends

• Declared at the discretion of the board of directors.

• Key characteristics of dividends:

  1. Not a liability until declared.

  2. Payments are from after-tax cash flow and not tax-deductible.

  3. Tax implications for individuals differ for corporate shareholders.

Preferred Stock Features

• Definition: Preferred stock provides a fixed dividend and preference over common stock in dividend payments and liquidation.

• Usually has no maturity date and often no voting rights.

Stated Value and Dividends

• Preferred shares typically have a stated liquidating value (e.g., $100 per share).

• Cumulative vs. Noncumulative Dividends:

  • Cumulative dividends must be paid before common dividends.

  • Directors can defer dividends without incurring debt.

Voting Rights and Preferences

• If preferred dividends are missed, holders may gain voting rights.

  • Example: US Airways allowed preferred stockholders to nominate representatives after missed payments.

Is Preferred Stock Really Debt?

• Similarities between preferred stock and debt:

  • Regular dividend payments resemble interest.

  • Often rated like bonds; may be convertible or callable.

  • Sinking funds create a final retirement plan for preferred stock.

• Tax treatment varies: dividends treated as common stock dividends for tax purposes.

Conclusion

• Despite features resembling debt, preferred stock remains classified as equity for tax purposes.