Capital Stock

What is Capital Stock?

Capital stock refers to the total amount of shares that a corporation is authorized to issue as stated in its articles of incorporation. These shares represent ownership in the company, giving shareholders a residual claim on corporate assets and earnings. There are two primary types of capital stock: common stock and preferred stock.

Common Stock

Common stockholders possess voting rights that typically allow them to influence corporate decisions during shareholder meetings. They also have the potential to benefit from dividends and capital appreciation. However, in the event of a liquidation, common stockholders are last in line to claim the company’s assets.

Preferred Stock

Preferred stockholders, on the other hand, do not usually have voting rights. However, they come with the advantage of having a higher claim on assets and earnings than common stockholders. They often receive fixed dividends before any payments are made to common stockholders. In the case of liquidation, preferred stockholders are paid off before common stockholders but after debt holders.

Examples:

TechCorp Inc.: TechCorp has issued 1 million shares of common stock and 200,000 shares of preferred stock. Bailey, who holds common stock, enjoys voting rights and hopes for capital gains. Jordan, who holds preferred stock, receives a fixed quarterly dividend and has a higher claim on assets than common stockholders but does not participate in voting.
RetailCo Ltd.: RetailCo, a retail-focused company, issued 500,000 shares of common stock for raising capital with the consent of the shareholders. The common stockholders are primarily interested in dividends and the share price appreciation, even though their claim on company assets, in case of liquidation, is lower than that of preferred stockholders.

Frequently Asked Questions (FAQs)

What is the main difference between common stock and preferred stock?

The primary distinction lies in the rights and benefits provided. Common stockholders typically have voting rights and a potential for higher capital gains, while preferred stockholders have preferential treatment in dividends and claims on assets but usually lack voting rights.

Can a company have both common and preferred stock?

Yes, a corporation can issue both types of stock depending on its capital structure and financing strategy. This allows the company to appeal to a broader range of investors.

How is capital stock different from authorized stock?

While ‘capital stock’ refers to the shares that have been issued and are outstanding, ‘authorized stock’ is the maximum number of shares that a company is legally allowed to issue, as specified by its corporate charter.

What rights do common stockholders have?

Common stockholders typically have voting rights, the right to receive dividends, the right to receive information about the corporation, and a residual claim on assets in case of liquidation.

Do preferred shareholders get to vote in corporate decisions?

Whether preferred shareholders have voting rights depends on the terms set by the corporation, though traditionally, preferred shareholders do not have voting rights.

Authorized Stock: The maximum number of shares a corporation is permitted to issue as per its corporate charter.
Dividends: A distribution of a portion of a company’s earnings to its shareholders.
Liquidation: The process of bringing a business to an end and distributing its assets to claimants.
Shareholders’ Equity: The residual interest in the assets of the enterprise after deducting liabilities.
Par Value: The face value of a stock, as stated in the corporate charter.

Online References

Suggested Books for Further Studies

“Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
“Accounting and Finance for Non-Specialists” by Peter Atrill and Eddie McLaney
“Corporate Finance: The Core” by Jonathan Berk and Peter DeMarzo

Accounting Basics: “Capital Stock” Fundamentals Quiz

### What are the two main types of capital stock? - [x] Common stock and preferred stock - [ ] Treasury stock and common stock - [ ] Common stock and authorized stock - [ ] Authorized stock and preferred stock > **Explanation:** Capital stock primarily consists of two types: common stock and preferred stock, each with distinct rights and privileges. ### Which type of capital stock usually does not come with voting rights? - [ ] Common stock - [ ] both Common and Preferred stock - [x] Preferred stock - [ ] Treasury stock > **Explanation:** Preferred stockholders typically do not have voting rights, unlike common stockholders who usually possess such rights. ### Who has a higher claim on assets in case of company liquidation? - [x] Preferred stockholders - [ ] Common stockholders - [ ] Both have equal claims - [ ] Bondholders > **Explanation:** Preferred stockholders have a higher claim on the assets and earnings of a corporation than common stockholders during liquidation. ### Which stock type may provide a fixed dividend? - [ ] Common stock - [x] Preferred stock - [ ] Treasury stock - [ ] Authorized stock > **Explanation:** Preferred stock generally offers fixed dividends, which are paid out before any dividends are given to common stockholders. ### During a shareholder meeting, who is likely to have a vote? - [x] Common stockholders - [ ] Preferred stockholders - [ ] Bondholders - [ ] All of the above > **Explanation:** Common stockholders typically possess voting rights enabling them to participate in corporate decision-making processes during shareholder meetings. ### Which type of capital stock is often considered more stable in terms of dividends? - [ ] Common stock - [x] Preferred stock - [ ] Authorized stock - [ ] Both are equally stable > **Explanation:** Preferred stock dividends are typically more stable and predictable than those of common stock, where dividends can vary based on profits and corporate decisions. ### What is the maximum number of shares a company can issue called? - [ ] Issued stock - [x] Authorized stock - [ ] Preferred stock - [ ] Common stock > **Explanation:** The maximum number of shares that a company can issue is known as authorized stock, as determined by its corporate charter. ### Which shareholders are paid first in case of dividends? - [ ] Common stockholders - [x] Preferred stockholders - [ ] Both at the same time - [ ] Bondholders > **Explanation:** Preferred stockholders are paid dividends before common stockholders, reflecting their preferential status in the capital structure. ### What is another term used to refer to ownership shares in a corporation? - [x] Capital stock - [ ] Preferred equity - [ ] Authorized shares - [ ] Voting stock > **Explanation:** Ownership shares in a corporation are often referred to as capital stock, encompassing both common and preferred stock. ### Why might an investor choose preferred stock over common stock? - [x] To receive fixed dividends and have higher asset claim - [ ] To gain voting rights and influence corporate decisions - [ ] To experience higher stock price volatility - [ ] To avoid receiving dividends > **Explanation:** An investor might choose preferred stock to benefit from fixed dividends and a higher claim on corporate assets in case of liquidation.

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