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,
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.
It is possible to have non-voting stock, which
has all the financial rights of common stock,
but lacks the power to choose directors or veto
As you can see, the returns
on common stock are uncertain. The company might
not have earnings with which to pay dividends.
The board might not declare dividends, but instead
reinvest earnings in the company. There may not
be a market into which to sell stock. The market
might, because of structural or informational
flaws, not value stock effinciently. The board
might approve a merger that imposes a price that
does not reflect the stock's future return potential.
The board might approve a dissolution and liquidation
of the company's assets at a price that does not
reflect the company's ongoing business value.
based on dividends
valuators focus on cash dividends. Why is this?
Some companies do not pay dividends, and most
companies pay less in dividends than has been
earned. In addition, many shareholders realize
returns when they sell the stock (capital gains)
or receive a higher price in a fundamental corporate
transaction, such as a merger.
In the end, stock has value because of the possibility
of cash returns:
- Earnings. Even if current earnings are retained
and reinvested, the reinvested earnings should
produce future earnings that eventually will
be paid as dividends.
- Capital gains. If a shareholder sells stock
on the market, it is because the buyer values
the potential for future returns - that is,
- Merger. If a company is acquired in a merger,
and its shareholders paid for their stock, the
acquirer values the company's potential for
creating returns - dividends.
For this reason, professional stock valuators
say that only dividends are relevant. But stock
markets are more realistic about human nature.
Market traders know, for example, that stock prices
in mergers often involve more than the acquirer's
valuation of future dividends. Sometimes the acquirer's
managers have big egos and just want to run a
bigger business! The selling shareholders know
this and will demand a higher merger price.
[The role of dividend policy Brudney & Bratton
Casebook 550-570; Supplement 97-103].
Class A vs. Class B common.
Although there are no standard definitions for
lettered classes of stock. Class A generally has
inferior voting rights to Class B
Publicly owned vs. closely held common.
Publicly-owned stocks have many owners, who trade
on stock exchanges and other public markets. Closely
held stocks have few owners, without a trading
market. (Some very big companies can be closely-held,
such as Wlamart until about 10 years ago.) Publicly
owned stock can be readily sold, and the company
can issue new shares. The drawbacks of publicly
owned stock include costly registration and reporting
requirements and the possibilty for hostile takeovers.
Company size. Stocks are often
categorized by size, specifically by the issuer's
market capitalization or the number of shares
outstanding times the share price.
$500 million to $2 billion
$2 billion to $10 billion
$10 billion to $100
More than $100 billion
Styles of stock. Stocks are
also categorized by their style:
|Company is expanding at above
average rate; Cisco of the late 1990s was
a growth stock.
|Stock whose price is seen as below its true
|Rise and fall with the economy; steel companies
are good examples
Stock sectors. Often referred
to depending on the sector of the underlying business.
The following are S&P's 10 sectors and examples
||GM, Home Depot, Walt Disney
||Pepsico, RJR, Sara Lee
||Exxon/Mobil, Noble Drilling, Halliburton
||Wachovia, Bank of America, Goldman Sachs
||Merck, Pfizer, Aetna
||Boeing, UPS, Delta
||Microsoft, Yahoo, Intel
||Alcoa, International Paper, U.S. Steel
||AT&T, Bellsouth, Verizon
||Duke Energy, Southern Co., Calpine
Not only have dividends contributed almost half
of the stock market's long-run total return, but
also they have provided investors with a remarkably
reliable stream of income. In fact, a good case
can be made that stocks are a better source of
income than bonds. (More>>)
Marriage of common and
... they are generically called "income
trusts" in Canada and Income Deposit Securities,
or IDS, in the U.S. All work on essentially the
same concept. They typically stitch together a
share of company equity with a company's junk-rated
bonds, making them saleable in one "unit,"
much like a real-estate investment trust.
Instead of trading on a company's growth prospects,
IDS units are valued on the consistency of their
cash flows. Those cash flows are nearly all paid
to shareholders in the form of quarterly dividends
and bond interest payments. Banks expect that
IDS issuers will pay annual yields of 8% to 11%,
which they are hoping will attract investors still
hungry for dividends in the wake of last year's
dividend-tax rollbacks. (More>>)
"Payout Policy in the
BY: ALON BRAV - Duke University, Fuqua School
of Business / JOHN ROBERT GRAHAM - Duke University
/ CAMPBELL R. HARVEY - Duke University, Fuqua
School of Business National Bureau of Economic
Research (NBER) / RONI MICHAELY - Cornell University,
Samuel Curtis Johnson Graduate School of Management
Document: Available from the SSRN Electronic
Paper Collection: SSRN
Date: February 2003
We survey 384 CFOs and Treasurers, and conduct
in-depth interviews with an additional two dozen,
to determine the key factors that drive dividend
and share repurchase policies. Consistent with
Lintner (1956), we find that managers are very
reluctant to cut dividends, that dividends are
smoothed through time, and that dividend increases
are tied to long-run sustainable earnings but
much less so than in the past. Managers are less
enthusiastic than in the past about increasing
dividends and see repurchases as an alternative.
Paying out in the form of repurchases is viewed
by managers as more flexible than using dividends,
permitting a better opportunity to optimize investment.
Managers like to repurchase shares when they feel
their stock is undervalued and in an effort to
affect EPS. Dividend increases and the level of
share repurchases are generally paid out of residual
cash flow, after investment and liquidity needs
Financial executives believe that retail investors
have a strong preference for dividends, in spite
of their tax disadvantage relative to repurchases.
In contrast, they believe that institutional investors
as a class have no strong preference between dividends
and repurchases. In general, management views
provide at most moderate support for agency and
clientele hypotheses of payout policy; and even
less support for the signaling stories. Tax considerations
play only a secondary role. By highlighting where
the theory and practice of corporate payout policy
are consistent and where they are not, we attempt
to shed new light on important unresolved issues
related to payout policy in the 21st century.