Chapter 1: What is a Security? - B. Corporate Time Line

Authorized Stock

Authorized stock is the maximum number of shares that a company may sell to the investing public in an effort to raise cash to meet the organization’s goals. The number of authorized shares is arbitrarily determined and is set at the time of incorporation. A corporation may sell all or part of its authorized stock. If the corporation wants to sell more shares than it is authorized to sell, the shareholders must approve an increase in the number of authorized shares.

Issued Stock

Issued stock is stock that has been authorized for sale and has actually been sold to the investing public. The total number of authorized shares typically exceeds the total number of issued shares so that the corporation may sell additional shares in the future to meet its needs. Once shares have been sold to the investing public, they will always be counted as issued shares regardless of their ownership or subsequent repurchase by the corporation. It is important to note that the total number of issued shares may never exceed the total number of authorized shares.

Additional authorized shares may be issued in the future to:

  • Pay a stock dividend
  • Expand current operations
  • Exchange common shares for convertible preferred or convertible bonds
  • Satisfy obligations under employee stock options or purchase plans

Outstanding Stock

Outstanding stock is stock that has been sold or issued to the investing public and that actually remains in the hands of the investing public.

Treasury Stock

Treasury stock is stock that has been sold to the investing public, which has subsequently been repurchased by the corporation. The corporation may elect to reissue the shares or it may retire the shares that it holds in Treasury stock. Treasury stock does not receive dividends nor does it vote.

A corporation may elect to repurchase its own shares to:

  • Maintain control of the company
  • Increase earnings per share
  • Fund employee stock purchase plans
  • Use shares to pay for a merger or acquisition

To determine the amount of Treasury stock, use the following formula:

issued stock – outstanding stock = treasury stock

Values of Common Stock

The market value of a common stock is determined by supply and demand and may or may not have any real relationship to what the shares are actually worth. The market value of common stock is affected by the current and future expectations for the company.

Book Value

The book value of a corporation is the theoretical liquidation value of the company. It is calculated by taking all of the company’s tangible assets and subtracting all of its liabilities. To determine the book value per share, divide the total book value by the total number of outstanding common shares.

Par Value

Par value in a discussion regarding common stock is only important if you are an accountant looking at the balance sheet. For investors, it has no relationship to any measure of value that may otherwise be employed.

Rights of Common Stockholders

As an owner of common stock, investors are owners of the corporation. As such, investors have certain rights that are granted to all common stockholders.

Preemptive Rights

As a stockholder, an investor has the right to maintain a percentage interest in the company. This is known as a preemptive right. Should the company wish to sell additional shares to raise new capital, it must first offer the new shares to existing shareholders. If the existing shareholders decide not to purchase the new shares, they may be offered to the general public.

Test Focus!

Number of Existing Shares

Number of New Shares

Total Shares After Offering

100,000

100,000

200,000

10,000

10,000

20,000

10% ownership

10% of offering

10% ownership

In the example above, the company has 100,000 shares of stock outstanding and an investor has purchased 10,000 of those original shares. As a result, they own 10% of the corporation. The company wishing to sell 100,000 new shares to raise new capital must first offer 10% of the new shares to the current investor (10,000 shares) before the shares may be offered to the general public. So if the investor decides to purchase the additional shares, as is the case in the example, the investor will have maintained their 10% interest in the company.

A shareholder’s preemptive right is ensured through a rights offering. The existing share­holders will have the right to purchase the new shares at a discount to the current market value for 45 days. This is known as the subscription price. Once the subscription price is set, it remains constant for 45 days, while the price of the stock is moving up and down in the market place. There are three possible outcomes for a right. They are:

Exercised

The investor decides to purchase the additional shares and sends in the money as well as the rights to receive the additional shares.

Sold

The rights have value and if the investor does not want to purchase the additional shares they may be sold to another investor who would like to purchase the shares.

Expire

The rights will expire if no one wants to purchase the stock. This will only occur when the market price of the share has fallen below the subscription price of the right and the 45 days have elapsed.

Voting

A common stockholder has the right to vote on major issues facing the corporation. They are part owners of the company, and as a result, have the right to say how the company is run. The biggest emphasis is placed on the election of the board of directors.

Common stockholders may also vote on:

  • The issuance of bonds or additional common shares
  • Stock splits
  • Mergers and acquisitions
  • Major changes in corporate policy

Methods of Voting

There are two methods by which the voting process may be conducted: the statutory and cumulative methods. A stockholder may cast one vote for each share of stock owned and the statutory or cumulative methods will determine how those votes are cast. The test focuses on the election of the board of directors, so we will use that in our example.

Example:

An investor owns 200 shares of XYZ. There are two board members to be elected and there are four people running in the election. Under both the statutory and cumulative methods of voting, the number of votes the shareholder has is decided by multiplying the number of shares owned by the number of people to be elected. In this case, 200 shares x 2 = 400 votes. The cumulative or statutory methods dictate how those votes may be cast.

Candidate

Statutory

Cumulative

1

200 votes

400 votes

2

3

4

200 votes

The statutory method requires that the votes be distributed evenly among the candidates the investor wishes to vote for.

The cumulative method allows the shareholder to cast all of their votes in favor of one candidate if they so choose. The cumulative method is said to favor smaller investors for this reason.

Limited Liability

Stockholders’ liability is limited to the amount of money they have invested in the stock. They cannot be held liable for any amount that exceeds their invested capital.

Inspection of Books and Records

All stockholders have the right to inspect the company’s books and records. For most shareholders this right is ensured through the company’s filing of quarterly and annual reports. Stockholders also have the right to obtain a list of shareholders, but they do not have the right to review other corporate financial data that the corporation may deem confidential.

Residual Claim to Assets

In the event of a company’s bankruptcy or liquidation, common stockholders have the right to receive their proportional interest in residual assets. After all other security holders as well as all creditors of the corporation have been paid, common stockholders may claim the residual assets. For this reason, common stock is the most junior security.

C. Why Do People Buy Common Stock?


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