Reading: Lesson 1 - Types of Common Stock & Stock Market Reporting

7.1.A - Types of Common Stock & Stock Market Reporting

1. Legal Rights and Privileges of Common Stockholders

1. Common stockholders are the owners of a corporation, and as such they have certain rights and privileges. 
   
2. A firm’s common stockholders have the right to elect its directors, who, in turn, elect the officers who manage the business. In a small firm, the largest stockholder typically serves as president and chairperson of the board. In a large, publicly owned firm, the managers typically have some stock, but their personal holdings are generally insufficient to give them voting control. Thus, the managers of most publicly owned firms can be removed by the stockholders if the management team is not effective.
   
3. Corporations must hold periodic elections to select directors, usually once a year, with the vote taken at the annual meeting. At some companies, all directors are elected each year for a 1-year term. At other companies, the terms are staggered. For example, one-third of the directors are elected each year for a 3-year term.
   
4. Each share of stock has one vote, so the owner of 1,000 shares has 1,000 votes for each director. Stockholders can appear at the annual meeting and vote in person, but typically they transfer their right to vote to another party by means of a proxy. Management always solicits stockholders’ proxies and usually gets them. However, if earnings are poor and stockholders are dissatisfied, an outside group may solicit the proxies in an effort to overthrow management and take control of the business. This is known as a proxy fight.
   
5. Common stockholders often have the right, called the preemptive right, to purchase any additional shares sold by the firm. In some states, the preemptive right is automatically included in every corporate charter; in others, it is used only if it is specifically inserted into the charter.
   
6. The preemptive right enables current stockholders to maintain control, and it also prevents a transfer of wealth from current stockholders to new stockholders. If not for this safeguard, the management of a corporation could issue additional shares at a low price and purchase these shares itself. Management could thereby seize control of the corporation and steal value from the current stockholders. For example, suppose 1,000 shares of common stock, each with a price of $100, were outstanding, making the total market value of the firm $100,000. If an additional 1,000 shares were sold at $50 a share, or for $50,000, this would raise the total market value to $150,000. When total market value is divided by new total shares outstanding, a value of $75 a share is obtained. The old stockholders thus lose $25 per share, and the new stockholders have an instant profit of $25 per share. Thus, selling common stock at a price below the market value would dilute its price and transfer wealth from the present stockholders to those who were allowed to purchase the new shares. The preemptive right prevents such occurrences.
   

2. Types of Common Stock

1. Although most firms have only one type of common stock, in some instances companies use classified stock to meet special needs. Generally, when special classifications are used, one type is designated Class A, another Class B, and so on. Small, new companies seeking funds from outside sources frequently use different types of common stock. For example, when Genetic Concepts went public, its Class A stock was sold to the public and paid a dividend, but this stock had no voting rights for 5 years. Its Class B stock, which the firm’s organizers retained, had full voting rights for 5 years, but the legal terms stated that the company could not pay dividends on the Class B stock until it had established its earning power and built up retained earnings to a designated level. The use of classified stock thus enabled the public to take a position in a conservatively financed growth company without sacrificing income, while the founders retained absolute control during the crucial early stages of the firm’s development. At the same time, outside investors were protected against excessive withdrawals of funds by the original owners. As is often the case in such situations, the Class B stock was called founders’ shares.
   
2. As these examples illustrate, the right to vote is often a distinguishing characteristic between different classes of stock. Suppose two classes of stock differ in only one respect: One class has voting rights but the other does not. As you would expect, the stock with voting rights would be more valuable. In the United States, which has a legal system with fairly strong protection for minority stockholders (that is, noncontrolling stockholders), voting stock typically sells at a price 4% to 6% above that of otherwise similar nonvoting stock. Thus, if a stock with no voting rights sold for $50, then one with voting rights would probably sell for $52 to $53. In countries with legal systems that provide less protection for minority stockholders, the right to vote is far more valuable. For example voting stock in Israel sells for 45% more on average than nonvoting stock, and voting stock in Italy has an 82% higher value than nonvoting stock.
   
3. Some companies have multiple lines of business, with each line having different growth prospects. Because cash flows for all business lines are mingled on financial statements, some companies worry that investors are not able to value the high-growth business lines correctly. To separate the cash flows and to allow separate valuations, occasionally a company will have classes of stock with dividends tied to a particular part of a company. This is called tracking stock, or target stock. For example, in 2006 Liberty Media Corporation, a conglomerate that owned such entertainment assets as the Starz movie channel and investments in Time Warner, issued two different tracking stocks to track its two different business lines. One of these, Liberty Interactive tracking stock, was designed to track the performance of its QVC home shopping network and other high-growth Internet-based interactive assets. The other, Liberty Capital Group, comprised slower-growth holdings like the Starz Entertainment Group. The idea was that investors would assign a higher value to the high growth portion of the company if it traded separately.
   
4. However, many analysts are skeptical as to whether tracking stock increases a company’s total market value. Companies still report consolidated financial statements for the entire company and have considerable leeway in allocating costs, deploying capital, and reporting the financial results for the various divisions, even those with tracking stock. Thus, a tracking stock is far from identical to the stock of an independent, stand-alone company.
   

3. Stock Market Reporting

1. Fifty years ago, investors who wanted real-time information would sit in brokerage firms’ offices watching a “ticker tape” go by that displayed prices of stocks as they were traded. Those who did not need current information could find the previous day’s prices from the business section of a daily newspaper like The Wall Street Journal. Today, though, one can get quotes throughout the day from many different Internet sources, including Yahoo!. The Figure below shows the quote for General Electric, which is traded on the NYSE under the symbol GE, on February 24, 2012. GE ended the regular trading day (4 p.m. EST) at $19.24, down $0.07, which was a 0.36% decrease from the previous day. However, in after-hours trading the stock fell by an additional 3 cents. The data also show that GE opened the day at $19.36 and traded in a range from $19.14 to $19.37. If this quote had been obtained during trading hours, it would also have provided current information about the quotes at which the stock could be bought (the Ask quote) or sold (the Bid quote). During past 52 weeks, the price hit a high of $21.17 and a low of $14.02. A total of 23.93 million GE shares traded that day, which was below the average trading volume of 58.20 million shares during the past 3 months.
   
2. The screen with the stock quote information also gives the total market value of GE’s common stock (the Market Cap), the dividend, the dividend yield, the most recent “ttm” (“trailing twelve months”) EPS and P/E ratios, and a graph showing the stock’s performance during the day. (However, the graph can be changed to show the stock’s performance over a number of time periods up to and including 5 years.) In addition to this information, the Web page has links to financial statements, research reports, historical ratios, analysts’ forecasts of EPS and EPS growth rates, and a wealth of other data.