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Say you just bought stock in Disney. As a part owner of the company does this mean you and the family can hit Disneyland for free this summer? Why is it that Anheuser-Busch shareholders don't get a case of beer each quarter? (forget the dividends!) Although these perks are highly unlikely, they do raise a good question: what rights and privileges do shareholders have? While they may not be entitled to free rides and beer, many investors are unaware of their rights as shareowners. In this article we discuss what privileges come with being a shareholder and which do not. (To learn more about shareholder rights and responsibilities, see also Proxy Voting Gives Fund Shareholders A Say.)
Levels of Ownership Rights
Before getting into the nitty-gritty of shareholder rights, let's first look at a company’s pecking order. Every company has a hierarchical structure of rights which accompany the three main classes of securities that companies issue: bonds, preferred stock, and common stock (To learn more, see our Stocks Basics Tutorial.)
The priority of each security is best understood by looking at what happens when a company goes bankrupt. You may think that as an owner you'd be first in line for getting a portion of the company’s assets if it went belly up. After all, you did pay for them. In reality, as a common shareholder you are at the very bottom of the corporate food chain when a company liquidates (you are the corporate equivalent of a hyena that eats only after the lions have eaten their share). During insolvency proceedings, it is the creditors who first get dibs on the company’s assets to settle their outstanding debts, then the bondholders get first crack at those leftovers, followed by preferred shareholders and finally the common shareholders. This hierarchy forms according to the principle of absolute priority.
In addition to the rules of absolute priority, there are other rights which differ with each class of security. For example, usually a company's charter states that only the common stockholders have voting privileges and preferred stockholders must receive dividends before common stockholders. The rights of bondholders are determined differently because a bond agreement, or indenture, represents a contract between the issuer and the bondholder. The payments and privileges the bondholder receives are governed by the indenture (tenets of the contract).
Risks and Rewards
Sounds pretty bad for common shareholders, doesn't it? Don’t be fooled, common shareholders are still the part owners of the business and if the business is able to turn a profit, then common shareholders gain. The liquidation preference we described makes logical sense: shareholders take on a greater risk (they receive next to nothing if the firm goes bankrupt) but they also have a greater reward potential through exposure to share price appreciation, when the company succeeds. Whereas preferred stock is usually less in number, held by a select few and generally sees less fluctuations in its price.
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