Stock ownership comes in two flavors: common and preferred. Common stock offers voting rights and potential for growth, while preferred stock provides fixed dividends and higher claims on assets. These differences impact investor returns and company decisions.

Understanding stock characteristics is crucial for grasping a company's capital structure. The mix of common and preferred stock affects financial flexibility, shareholder influence, and overall cost of capital. It's a balancing act for companies seeking optimal funding.

Common vs Preferred Stock Features

Ownership and Security Characteristics

• Common stock represents an ownership interest in a company
• Preferred stock represents a hybrid security with characteristics of both debt and equity

Voting Rights and Returns

• Common stockholders have voting rights and the potential for capital appreciation
• Preferred stockholders typically do not have voting rights but receive priority in dividend payments and asset claims

Dividend Payments

• Common stock dividends are not guaranteed and can fluctuate based on company performance and board decisions
• Preferred stock dividends are generally fixed and must be paid before any common stock dividends

Liquidation Priority

• In the event of liquidation, preferred stockholders have a higher claim on company assets compared to common stockholders
• However, preferred stockholders have a lower claim on assets than bondholders

Dilution Impact

• Common stock issuance can dilute ownership and voting power for existing common stockholders
• Preferred stock issuance does not affect the ownership structure of common stockholders

Rights and Privileges of Stock Ownership

Voting Rights

• Common stockholders have the right to vote on important corporate matters (electing board members, approving mergers or acquisitions)
• Preferred stockholders typically do not have voting rights

Capital Appreciation Potential

• Common stockholders have the potential for unlimited capital appreciation as the company grows and becomes more profitable
• Preferred stockholders' returns are generally limited to the fixed dividend payments

Asset and Earnings Claims

• Preferred stockholders have a higher claim on assets and earnings compared to common stockholders
• This provides preferred stockholders with a greater degree of safety and stability

Dividend Payment Priority

• Preferred stockholders receive priority in dividend payments
• The company must pay all accumulated preferred dividends before distributing any dividends to common stockholders

Additional Preferred Stock Features

• Some preferred stocks may have additional features:
  • Convertibility into common stock
  • Callability by the issuer (company can repurchase shares at a predetermined price)
  • Participation in excess dividends beyond the stated rate

Stock Characteristics and Company Decisions

Capital Structure Impact

• The proportion of common and preferred stock in a company's capital structure affects its overall cost of capital
  • Each type of stock has different risk and return profiles
• A higher proportion of preferred stock in the capital structure can provide a tax advantage
  • Preferred stock dividends are tax-deductible for the issuing company, unlike common stock dividends

Financial Flexibility

• The presence of preferred stock can limit a company's financial flexibility
  • Preferred dividend obligations must be met before any common stock dividends can be paid or reinvested in the business

Shareholder Influence

• The voting rights associated with common stock can influence corporate decision-making
  • Common stockholders can pressure management to make decisions aligned with their interests

Dilution Considerations

• The potential for common stock dilution through additional issuances can impact a company's decision to raise capital
  • It may affect the ownership structure and voting power of existing shareholders

Balancing Benefits and Drawbacks

• Companies must balance the benefits and drawbacks of each type of stock when making capital structure decisions
• Factors to consider include:
  • Cost of capital
  • Financial flexibility
  • Shareholder alignment