20-1
Chapter 20
Long-Term Debt,
Preferred Stock,and
Common Stock
20-2
Long-Term Debt,Preferred
Stock,and Common Stock
? Bonds and Their Features
? Types of Long-Term Debt
Instruments
? Retirement of Bonds
? Preferred Stock and Its Features
? Rights of Common Shareholders
? Dual-Class Common Stock
20-3
Bonds and Their Features
Basic Terms
Par Value Coupon Rate
Maturity Bond Ratings
Bond -- A long-term debt instrument
with a final maturity generally being
10 years or more,
20-4
Trustee and Indenture
Trustee -- A person or institution designated
by a bond issuer as the official
representative of the bondholders,Typically,
a bank serves as trustee.
Indenture -- The legal agreement,also called
the deed of trust,between the corporation
issuing bonds and the bondholders,
establishing the terms of the bond issue and
naming the trustee.
20-5
Types of Long-Term
Debt Instruments
? Investors look to the earning power of the firm as
their primary security.
? Investors receive some protection by the
restrictions imposed in the bond indenture,
particularly any negative-pledge clause.
? A negative-pledge clause precludes the corporation
from pledging any of its assets (not already
pledged) to other creditors,
Debenture -- A long-term,unsecured debt
instrument.
20-6
Types of Long-Term
Debt Instruments
? In this case,subordinated debenture holders rank
behind debenture holders but ahead of preferred and
common stockholders in the event of liquidation.
? Frequently,the security is convertible into common
stock to lower the yield required by subordinated
debenture holders (often less than regular debentures).
Subordinated Debenture -- A long-term,
unsecured debt instrument with a lower claim
on assets and income than other classes of
debt; known as junior debt.
20-7
Types of Long-Term
Debt Instruments
? Frequently,there is a cumulative feature,which
provides that any unpaid interest in a particular year
accumulates,The cumulative obligation is usually
limited to no more than three years.
? The bonds are unpopular with investors (usually
limited to reorganizations),but are still senior to
preferred and common shareholders in the event of
liquidation.
Income Bond -- A bond where the payment of
interest is contingent upon sufficient
earnings of the firm.
20-8
Types of Long-Term
Debt Instruments
? These are bonds with a rating of Ba (Moody's) or lower.
? Principal investors are pension funds,high-yield bond
mutual funds,and some individual investors.
? Liquidity varies depending on investor sentiments.
? Junk bonds were used frequently in the 1980s as a
means of financing leveraged buyouts (LBOs).
Junk Bond -- A high-risk,high-yield (often
unsecured) bond rated below investment
grade.
20-9
Types of Long-Term
Debt Instruments
? The issue is secured by a lien on specific
assets of the corporation.
? The market value of the collateral should
exceed the amount of the bond issue by a
reasonable margin of safety to help protect
bondholders.
Mortgage Bond -- A bond issue secured by a
mortgage on the issuer’s property.
20-10
Types of Long-Term
Debt Instruments
? If the corporation defaults,the trustee can
foreclose on behalf of the bondholders,The
bondholders become general creditors for any
residual amount after the sale of the collateral.
? The corporation may have have a first
mortgage and a second mortgage on the same
assets,The first mortgage has a senior claim
on the assets.
Mortgage Bond (Continued)
20-11
Types of Long-Term
Debt Instruments
? A railroad arranges with a trustee to purchase
equipment from a manufacturer.
? The railroad signs a contract with the manufacturer
for the construction of specific equipment.
? When the equipment is delivered,equipment trust
certificates are sold to investors.
Equipment Trust Certificate -- An intermediate- to
long-term security,usually issued by a transportation
company such as a railroad or airline,that is used to
finance new equipment.
Let us look at an example using a railroad.
20-12
Types of Long-Term
Debt Instruments
? Proceeds plus the railroad downpayment are used
to pay the manufacturer.
? Title of the equipment is held by the trustee and the
trustee leases the equipment to the railroad.
? Lease payments are used to pay a fixed dividend to
the certificate holders and to retire a specified
portion of the certificates at regular intervals.
? After the final lease payment (all certificates are
retired),title to the equipment passes to the
railroad.
Equipment Trust Certificates (Continued)
20-13
Retirement of Bonds
? The corporation makes a cash payment to the
trustee,which calls the bonds.
? The corporation purchases bonds in the open
market and delivers them to the trustee.
Sinking Fund -- Fund established to periodically
retire a portion of a security issue before
maturity,The corporation is required to make
periodic sinking-fund payments to a trustee.
Two forms for the sinking-fund
retirement of a bond:
20-14
Sinking Fund and the
Retirement of Bonds
? When bonds are called for redemption,the
bondholders will receive the sinking-fund
call price.
? The bonds are called on a lottery basis (by
their serial numbers) and published in
periodicals like the Wall Street Journal.
? Bonds should be purchased in the open
market if the market price is less than the
sinking-fund call price.
20-15
Sinking Fund and the
Retirement of Bonds
? Volatility in interest rates or a decline in the
credit quality of the firm could lower the
market price of the bond and enhance the
value to the firm of having this option.
? Bondholders may benefit from the orderly
retirement of debt (amortization effect)
which reduces the default risk of the firm
and adds liquidity to bonds outstanding.
20-16
Sinking Fund and the
Retirement of Bonds
? Many bond issues are designed to have a larger
final payment to pay off the debt.
? For example,a corporation may undertake a $10
million dollar,15-year bond issue,The firm is
obligated to make $500,000 sinking fund
payments in the 5th through 14th years,The
final balloon payment in the 15th year would be
for the remaining $5 million dollars of bonds,
Balloon Payment -- A payment on debt that
is much larger than other payments.
20-17
Serial Bonds
? For example,a $10 million dollar issue of
serial bonds might have $500,000 of
predetermined bonds maturing each year for
20 years.
? Investors are able to choose the maturity that
best fits their needs (wider investor appeal).
Serial Bonds -- An issue of bonds with
different maturities,as distinguished from
an issue where all bonds have identical
maturities (term bonds).
20-18
Call Provision
? Not all bonds are callable,In periods of low
interest (hence,low coupon) rates firms are
more likely to issue noncallable bonds.
? When a bond is callable,the call price is
usually above the par value of the bond and
often decreases over time.
Call Provision -- A feature in an indenture that
permits the issuer to repurchase securities at
a fixed price (or series of fixed prices) before
maturity; also called call feature.
20-19
Call Price
? For example,the call price for the first year
might equal the bond par value plus one-year’s
interest.
? According to when they can be exercised,call
provisions can be either immediate or deferred.
? The call provision provides financing flexibility
for the firm as conditions change.
Call Price -- The price at which a security with
a call provision can be purchased by the
issuer prior to the security’s maturity.
20-20
Value of the Call Privilege
? The call privilege is valuable to the firm to the
detriment of bondholders,As such,bondholders
require a premium for this additional risk in the
form of a higher yield.
? The greater the volatility of interest rates,the
greater the probability that the firm will call the
bonds,Thus,the call-option is more valuable all
else equal.
Callable-bond
value
Noncallable-
bond value
Call-option
value= -
20-21
Preferred Stock -- A type of stock that
promises a (usually) fixed dividend,but at
the discretion of the board of directors,
Preferred Stock
and Its Features
Basic Terms
Par Value
Dividend Rate
Maturity
20-22
Cumulative
Dividends Feature
? For example,if the board of directors omits a $6
preferred dividend for two years,it must pay preferred
shareholders $12 per share ($100 par value) before
any dividend can be paid to common shareholders.
? The corporation does not have to make up the
dividend even if it is profitable,as long as the firm has
no plans to pay dividends to common shareholders.
Cumulative Dividends Feature -- A requirement
that all cumulative unpaid dividends on the
preferred stock be paid before a dividend may
be paid on the common stock.
20-23
Participating Feature
? Preferred stockholders have a prior claim on income
and an opportunity for additional return if the
dividends to common stockholders exceed a certain
amount.
? A 6% participating preferred issue ($100 par) allows
holders to share equally in any dividend in excess of
$6,A $7 common dividend results in an extra $1
dividend to the participating preferred shareholders.
Participating Preferred Stock -- Preferred stock where
the holder is allowed to participate in increasing
dividends if the common stockholders receive
increasing dividends.
20-24
Voting Rights in
Special Situations
? Preferred stockholders are not normally given a voice
in management unless the company is unable to pay
preferred stock dividends during a specified period.
? If such a situation presents itself,the class of
preferred stockholders would be entitled to elect a
specified number of directors.
? Any situation in which the company defaults under
restrictions in the agreement (similar to bond
indenture) may lead to voting power for preferred
shareholders.
? Preferred shareholders cannot force the immediate
repayment of obligations (like debt obligations).
20-25
Retirement of
Preferred Stock
? Call Provision -- almost all issues carry a call provision
because of the infinite maturity,It is often a cheaper
method of retirement than open market purchases,
inviting tenders,or an exchange of securities.
? Sinking Fund -- like bonds,many preferred issues
provide for this method of retirement.
? Conversion -- certain issues are convertible into
common stock at the option of the preferred
stockholder,Used most frequently in the acquisition of
other companies (the transaction is not taxable to the
shareholders of the acquired firm).
20-26
Use of Preferred
Stock in Financing
? The corporate issuer uses irregularly because the
preferred dividend is not tax deductible,Utilities use
more frequently as the preferred dividend can be
accounted for when setting customer rates.
? The corporate investor is attracted to preferred stock as
generally 70% of dividends can be excluded from taxes.
? Flexibility in paying dividends and an infinite maturity
(similar to a perpetual loan) are significant advantages
to the corporate issuer,
? The after-tax cost of preferred financing is greater than
that of long-term debt financing to the corporate issuer.
20-27
Common Stock
and Its Features
Basic Terms
Authorized Shares
Issued Shares
Outstanding Shares
Common Stock -- Securities that
represent the ultimate ownership (and
risk) position in a corporation,
20-28
Types of
Common Stock
Value
? It is merely a recorded figure in the corporate
charter and is of little economic consequence.
? Stock should never be issued below par value as
shareholders would be legally liable for any
discount from par if the firm is liquidated.
? Common stock that is authorized without par value
(no-par stock) is carried on the books at the original
market price or at some assigned (or stated) value.
? The difference between the issuing price and the par
or stated value is additional paid-in-capital.
A,Par Value -- The face value.
20-29
Example of Value
FunFinMan,Inc.
Common stock ($1 par value; 100,000
shares issued and outstanding) $ 100,000
Additional paid-in capital 400,000
Retained earnings 650,000
Total shareholders?equity $1,150,000
The par value of FunFinMan,Inc.,is $1 per share,
This value is not likely to change over time from
normal day-to-day operations.
20-30
Types of
Common Stock
Value
C,Liquidating Value (per share) -- The value per
share if the firm抯 assets are sold separately
from the operating organization.
? This value may be less (or greater) than
book value,Rarely are the two values
identical.
B,Book Value (per share) -- Shareholders?equity
(as listed on the balance sheet) divided by the
number of shares outstanding,
20-31
Example of Book
Value (per share)
FunFinMan,Inc.
Common stock ($1 par value; 100,000
shares issued and outstanding) $ 100,000
Additional paid-in capital 400,000
Retained earnings 650,000
Total shareholders?equity $1,150,000
The book value (per share) of FunFinMan,Inc.,is
determined by dividing total shareholders?equity
($1,150,000) by the shares outstanding (100,000),
which yields a book value of $11.50 per share,This
value is not likely to change over time from normal
day-to-day operations.
20-32
Types of
Common Stock
Value
? This value is usually greater than book
value (per share),but can occasionally be
less than book value (per share) for firms
that have been,are or expected to be in
financial difficulties,Rarely are the two
values identical.
? Market value (per share) may be difficult to
obtain from thinly traded securities.
D,Market Value (per share) -- The current price
at which the stock is currently trading,
20-33
Types of
Common Stock
Value
? Typically,the shares of new
companies are traded in the over-the-
counter (OTC) market,where dealers
maintain an inventory of the stock to
provide additional liquidity,
D,Market Value (per share) -- continued,
20-34
Rights of
Common
Shareholders
? Right to Income -- entitled to share in the earnings of
the company only if cash dividends are paid (via
approval by the board of directors).
? Right to Purchase New Shares (Maybe) -- the
corporate charter of state statute may provide current
shareholders with a preemptive right,which requires
that these shareholders be first offered any new issue
of common stock or an issue that can be converted
into common stock.
? Voting Rights -- because the shareholders are owners
of the firm,they are entitled to elect the board of
directors.
20-35
Voting Rights
? Shareholders are generally geographically widely
dispersed.
? Two methods of voting,(1) in person or (2) by proxy
Proxy -- A legal document giving one person
authority to act for another.
? SEC regulates the solicitation of proxies and requires
companies to disseminate information to their
shareholders through proxy mailings.
? Most shareholders,if satisfied with company
performance,sign proxies in behalf of management.
20-36
Voting Procedures
? Majority-rule voting -- a method of electing corporate
directors,where each common share held carries one
vote for each director position that is open; also called
statutory voting.
? Cumulative voting -- a method of electing corporate
directors,where each common share held carries as
many votes as there are directors to be elected and
each shareholder may accumulate these votes and
cast them in any fashion for one or more particular
directors.
The board of directors are elected under either:
20-37
Voting
Procedures
Example
? Under majority-rule voting,You may cast 100 votes
(1 per share) for each of the 9 director positions open
for a maximum of 100 votes per position.
? Under cumulative voting,You may cast 900 votes
(100 votes x 9 positions) for a single position or
divide the votes amongst the 9 open positions in any
manner you desire.
You are a shareholder of FunFinMan,Inc,You
own 100 shares and there are 10 director
positions to be filled.
20-38
Minimum Votes to Elect
a Director -- Cumulative
? For example,to elect 3 directors out of 9 director
positions at FunFinMan,Inc.,(100,000 voting shares
outstanding) would require 30,001 voting shares.
? (100,000 shares) x (3 directors)
10
Total number of
voting shares
Specific number of
directors sought
Total number of directors to be elected + 1
X + 1
+ 1 = 30,001 shares
20-39
Minimum Votes to Elect
a Director -- Cumulative
? Notice,that slightly over 30% of total voting shares
are necessary to guarantee the election of three of
the nine director positions -- less than a majority.
? Management can reduce the influence of minority
shareholders by reducing the number of directors or
staggering the election terms of directors so fewer
positions are open at each vote.
? Reducing the number of directors up for election
from 9 to 4 would increase the votes necessary to
elect 3 directors to 60,001 shares (twice as many)!
20-40
Dual-Class
Common Stock
? This is used to retain control for founders,
management,or some other specific group.
? For example,80,000 shares of Class A at
$20/share and 200,000 shares of Class B at
$2/share,Class A puts up 80% of the funds,but
Class B has over 70% of the votes,
? Usually Class B takes a lower claim to dividends
and assets than Class A for this voting control.
Dual-class common stock -- Two classes of common
stock,usually designated Class A and Class B,Class
A is usually the weaker voting or nonvoting class,and
Class B is usually the stronger.
Chapter 20
Long-Term Debt,
Preferred Stock,and
Common Stock
20-2
Long-Term Debt,Preferred
Stock,and Common Stock
? Bonds and Their Features
? Types of Long-Term Debt
Instruments
? Retirement of Bonds
? Preferred Stock and Its Features
? Rights of Common Shareholders
? Dual-Class Common Stock
20-3
Bonds and Their Features
Basic Terms
Par Value Coupon Rate
Maturity Bond Ratings
Bond -- A long-term debt instrument
with a final maturity generally being
10 years or more,
20-4
Trustee and Indenture
Trustee -- A person or institution designated
by a bond issuer as the official
representative of the bondholders,Typically,
a bank serves as trustee.
Indenture -- The legal agreement,also called
the deed of trust,between the corporation
issuing bonds and the bondholders,
establishing the terms of the bond issue and
naming the trustee.
20-5
Types of Long-Term
Debt Instruments
? Investors look to the earning power of the firm as
their primary security.
? Investors receive some protection by the
restrictions imposed in the bond indenture,
particularly any negative-pledge clause.
? A negative-pledge clause precludes the corporation
from pledging any of its assets (not already
pledged) to other creditors,
Debenture -- A long-term,unsecured debt
instrument.
20-6
Types of Long-Term
Debt Instruments
? In this case,subordinated debenture holders rank
behind debenture holders but ahead of preferred and
common stockholders in the event of liquidation.
? Frequently,the security is convertible into common
stock to lower the yield required by subordinated
debenture holders (often less than regular debentures).
Subordinated Debenture -- A long-term,
unsecured debt instrument with a lower claim
on assets and income than other classes of
debt; known as junior debt.
20-7
Types of Long-Term
Debt Instruments
? Frequently,there is a cumulative feature,which
provides that any unpaid interest in a particular year
accumulates,The cumulative obligation is usually
limited to no more than three years.
? The bonds are unpopular with investors (usually
limited to reorganizations),but are still senior to
preferred and common shareholders in the event of
liquidation.
Income Bond -- A bond where the payment of
interest is contingent upon sufficient
earnings of the firm.
20-8
Types of Long-Term
Debt Instruments
? These are bonds with a rating of Ba (Moody's) or lower.
? Principal investors are pension funds,high-yield bond
mutual funds,and some individual investors.
? Liquidity varies depending on investor sentiments.
? Junk bonds were used frequently in the 1980s as a
means of financing leveraged buyouts (LBOs).
Junk Bond -- A high-risk,high-yield (often
unsecured) bond rated below investment
grade.
20-9
Types of Long-Term
Debt Instruments
? The issue is secured by a lien on specific
assets of the corporation.
? The market value of the collateral should
exceed the amount of the bond issue by a
reasonable margin of safety to help protect
bondholders.
Mortgage Bond -- A bond issue secured by a
mortgage on the issuer’s property.
20-10
Types of Long-Term
Debt Instruments
? If the corporation defaults,the trustee can
foreclose on behalf of the bondholders,The
bondholders become general creditors for any
residual amount after the sale of the collateral.
? The corporation may have have a first
mortgage and a second mortgage on the same
assets,The first mortgage has a senior claim
on the assets.
Mortgage Bond (Continued)
20-11
Types of Long-Term
Debt Instruments
? A railroad arranges with a trustee to purchase
equipment from a manufacturer.
? The railroad signs a contract with the manufacturer
for the construction of specific equipment.
? When the equipment is delivered,equipment trust
certificates are sold to investors.
Equipment Trust Certificate -- An intermediate- to
long-term security,usually issued by a transportation
company such as a railroad or airline,that is used to
finance new equipment.
Let us look at an example using a railroad.
20-12
Types of Long-Term
Debt Instruments
? Proceeds plus the railroad downpayment are used
to pay the manufacturer.
? Title of the equipment is held by the trustee and the
trustee leases the equipment to the railroad.
? Lease payments are used to pay a fixed dividend to
the certificate holders and to retire a specified
portion of the certificates at regular intervals.
? After the final lease payment (all certificates are
retired),title to the equipment passes to the
railroad.
Equipment Trust Certificates (Continued)
20-13
Retirement of Bonds
? The corporation makes a cash payment to the
trustee,which calls the bonds.
? The corporation purchases bonds in the open
market and delivers them to the trustee.
Sinking Fund -- Fund established to periodically
retire a portion of a security issue before
maturity,The corporation is required to make
periodic sinking-fund payments to a trustee.
Two forms for the sinking-fund
retirement of a bond:
20-14
Sinking Fund and the
Retirement of Bonds
? When bonds are called for redemption,the
bondholders will receive the sinking-fund
call price.
? The bonds are called on a lottery basis (by
their serial numbers) and published in
periodicals like the Wall Street Journal.
? Bonds should be purchased in the open
market if the market price is less than the
sinking-fund call price.
20-15
Sinking Fund and the
Retirement of Bonds
? Volatility in interest rates or a decline in the
credit quality of the firm could lower the
market price of the bond and enhance the
value to the firm of having this option.
? Bondholders may benefit from the orderly
retirement of debt (amortization effect)
which reduces the default risk of the firm
and adds liquidity to bonds outstanding.
20-16
Sinking Fund and the
Retirement of Bonds
? Many bond issues are designed to have a larger
final payment to pay off the debt.
? For example,a corporation may undertake a $10
million dollar,15-year bond issue,The firm is
obligated to make $500,000 sinking fund
payments in the 5th through 14th years,The
final balloon payment in the 15th year would be
for the remaining $5 million dollars of bonds,
Balloon Payment -- A payment on debt that
is much larger than other payments.
20-17
Serial Bonds
? For example,a $10 million dollar issue of
serial bonds might have $500,000 of
predetermined bonds maturing each year for
20 years.
? Investors are able to choose the maturity that
best fits their needs (wider investor appeal).
Serial Bonds -- An issue of bonds with
different maturities,as distinguished from
an issue where all bonds have identical
maturities (term bonds).
20-18
Call Provision
? Not all bonds are callable,In periods of low
interest (hence,low coupon) rates firms are
more likely to issue noncallable bonds.
? When a bond is callable,the call price is
usually above the par value of the bond and
often decreases over time.
Call Provision -- A feature in an indenture that
permits the issuer to repurchase securities at
a fixed price (or series of fixed prices) before
maturity; also called call feature.
20-19
Call Price
? For example,the call price for the first year
might equal the bond par value plus one-year’s
interest.
? According to when they can be exercised,call
provisions can be either immediate or deferred.
? The call provision provides financing flexibility
for the firm as conditions change.
Call Price -- The price at which a security with
a call provision can be purchased by the
issuer prior to the security’s maturity.
20-20
Value of the Call Privilege
? The call privilege is valuable to the firm to the
detriment of bondholders,As such,bondholders
require a premium for this additional risk in the
form of a higher yield.
? The greater the volatility of interest rates,the
greater the probability that the firm will call the
bonds,Thus,the call-option is more valuable all
else equal.
Callable-bond
value
Noncallable-
bond value
Call-option
value= -
20-21
Preferred Stock -- A type of stock that
promises a (usually) fixed dividend,but at
the discretion of the board of directors,
Preferred Stock
and Its Features
Basic Terms
Par Value
Dividend Rate
Maturity
20-22
Cumulative
Dividends Feature
? For example,if the board of directors omits a $6
preferred dividend for two years,it must pay preferred
shareholders $12 per share ($100 par value) before
any dividend can be paid to common shareholders.
? The corporation does not have to make up the
dividend even if it is profitable,as long as the firm has
no plans to pay dividends to common shareholders.
Cumulative Dividends Feature -- A requirement
that all cumulative unpaid dividends on the
preferred stock be paid before a dividend may
be paid on the common stock.
20-23
Participating Feature
? Preferred stockholders have a prior claim on income
and an opportunity for additional return if the
dividends to common stockholders exceed a certain
amount.
? A 6% participating preferred issue ($100 par) allows
holders to share equally in any dividend in excess of
$6,A $7 common dividend results in an extra $1
dividend to the participating preferred shareholders.
Participating Preferred Stock -- Preferred stock where
the holder is allowed to participate in increasing
dividends if the common stockholders receive
increasing dividends.
20-24
Voting Rights in
Special Situations
? Preferred stockholders are not normally given a voice
in management unless the company is unable to pay
preferred stock dividends during a specified period.
? If such a situation presents itself,the class of
preferred stockholders would be entitled to elect a
specified number of directors.
? Any situation in which the company defaults under
restrictions in the agreement (similar to bond
indenture) may lead to voting power for preferred
shareholders.
? Preferred shareholders cannot force the immediate
repayment of obligations (like debt obligations).
20-25
Retirement of
Preferred Stock
? Call Provision -- almost all issues carry a call provision
because of the infinite maturity,It is often a cheaper
method of retirement than open market purchases,
inviting tenders,or an exchange of securities.
? Sinking Fund -- like bonds,many preferred issues
provide for this method of retirement.
? Conversion -- certain issues are convertible into
common stock at the option of the preferred
stockholder,Used most frequently in the acquisition of
other companies (the transaction is not taxable to the
shareholders of the acquired firm).
20-26
Use of Preferred
Stock in Financing
? The corporate issuer uses irregularly because the
preferred dividend is not tax deductible,Utilities use
more frequently as the preferred dividend can be
accounted for when setting customer rates.
? The corporate investor is attracted to preferred stock as
generally 70% of dividends can be excluded from taxes.
? Flexibility in paying dividends and an infinite maturity
(similar to a perpetual loan) are significant advantages
to the corporate issuer,
? The after-tax cost of preferred financing is greater than
that of long-term debt financing to the corporate issuer.
20-27
Common Stock
and Its Features
Basic Terms
Authorized Shares
Issued Shares
Outstanding Shares
Common Stock -- Securities that
represent the ultimate ownership (and
risk) position in a corporation,
20-28
Types of
Common Stock
Value
? It is merely a recorded figure in the corporate
charter and is of little economic consequence.
? Stock should never be issued below par value as
shareholders would be legally liable for any
discount from par if the firm is liquidated.
? Common stock that is authorized without par value
(no-par stock) is carried on the books at the original
market price or at some assigned (or stated) value.
? The difference between the issuing price and the par
or stated value is additional paid-in-capital.
A,Par Value -- The face value.
20-29
Example of Value
FunFinMan,Inc.
Common stock ($1 par value; 100,000
shares issued and outstanding) $ 100,000
Additional paid-in capital 400,000
Retained earnings 650,000
Total shareholders?equity $1,150,000
The par value of FunFinMan,Inc.,is $1 per share,
This value is not likely to change over time from
normal day-to-day operations.
20-30
Types of
Common Stock
Value
C,Liquidating Value (per share) -- The value per
share if the firm抯 assets are sold separately
from the operating organization.
? This value may be less (or greater) than
book value,Rarely are the two values
identical.
B,Book Value (per share) -- Shareholders?equity
(as listed on the balance sheet) divided by the
number of shares outstanding,
20-31
Example of Book
Value (per share)
FunFinMan,Inc.
Common stock ($1 par value; 100,000
shares issued and outstanding) $ 100,000
Additional paid-in capital 400,000
Retained earnings 650,000
Total shareholders?equity $1,150,000
The book value (per share) of FunFinMan,Inc.,is
determined by dividing total shareholders?equity
($1,150,000) by the shares outstanding (100,000),
which yields a book value of $11.50 per share,This
value is not likely to change over time from normal
day-to-day operations.
20-32
Types of
Common Stock
Value
? This value is usually greater than book
value (per share),but can occasionally be
less than book value (per share) for firms
that have been,are or expected to be in
financial difficulties,Rarely are the two
values identical.
? Market value (per share) may be difficult to
obtain from thinly traded securities.
D,Market Value (per share) -- The current price
at which the stock is currently trading,
20-33
Types of
Common Stock
Value
? Typically,the shares of new
companies are traded in the over-the-
counter (OTC) market,where dealers
maintain an inventory of the stock to
provide additional liquidity,
D,Market Value (per share) -- continued,
20-34
Rights of
Common
Shareholders
? Right to Income -- entitled to share in the earnings of
the company only if cash dividends are paid (via
approval by the board of directors).
? Right to Purchase New Shares (Maybe) -- the
corporate charter of state statute may provide current
shareholders with a preemptive right,which requires
that these shareholders be first offered any new issue
of common stock or an issue that can be converted
into common stock.
? Voting Rights -- because the shareholders are owners
of the firm,they are entitled to elect the board of
directors.
20-35
Voting Rights
? Shareholders are generally geographically widely
dispersed.
? Two methods of voting,(1) in person or (2) by proxy
Proxy -- A legal document giving one person
authority to act for another.
? SEC regulates the solicitation of proxies and requires
companies to disseminate information to their
shareholders through proxy mailings.
? Most shareholders,if satisfied with company
performance,sign proxies in behalf of management.
20-36
Voting Procedures
? Majority-rule voting -- a method of electing corporate
directors,where each common share held carries one
vote for each director position that is open; also called
statutory voting.
? Cumulative voting -- a method of electing corporate
directors,where each common share held carries as
many votes as there are directors to be elected and
each shareholder may accumulate these votes and
cast them in any fashion for one or more particular
directors.
The board of directors are elected under either:
20-37
Voting
Procedures
Example
? Under majority-rule voting,You may cast 100 votes
(1 per share) for each of the 9 director positions open
for a maximum of 100 votes per position.
? Under cumulative voting,You may cast 900 votes
(100 votes x 9 positions) for a single position or
divide the votes amongst the 9 open positions in any
manner you desire.
You are a shareholder of FunFinMan,Inc,You
own 100 shares and there are 10 director
positions to be filled.
20-38
Minimum Votes to Elect
a Director -- Cumulative
? For example,to elect 3 directors out of 9 director
positions at FunFinMan,Inc.,(100,000 voting shares
outstanding) would require 30,001 voting shares.
? (100,000 shares) x (3 directors)
10
Total number of
voting shares
Specific number of
directors sought
Total number of directors to be elected + 1
X + 1
+ 1 = 30,001 shares
20-39
Minimum Votes to Elect
a Director -- Cumulative
? Notice,that slightly over 30% of total voting shares
are necessary to guarantee the election of three of
the nine director positions -- less than a majority.
? Management can reduce the influence of minority
shareholders by reducing the number of directors or
staggering the election terms of directors so fewer
positions are open at each vote.
? Reducing the number of directors up for election
from 9 to 4 would increase the votes necessary to
elect 3 directors to 60,001 shares (twice as many)!
20-40
Dual-Class
Common Stock
? This is used to retain control for founders,
management,or some other specific group.
? For example,80,000 shares of Class A at
$20/share and 200,000 shares of Class B at
$2/share,Class A puts up 80% of the funds,but
Class B has over 70% of the votes,
? Usually Class B takes a lower claim to dividends
and assets than Class A for this voting control.
Dual-class common stock -- Two classes of common
stock,usually designated Class A and Class B,Class
A is usually the weaker voting or nonvoting class,and
Class B is usually the stronger.
