Shareholders’ equity is the phrase used to describe owners’ equity in a corporation.
The stockholders’ equity of a corporation is divided into two categories:
- Paid-in capital (also called contributed capital) represents amounts received from stockholders. Common stock, discussed in Chapter 1, is the main source of paid-in capital. This is externally generated stockholders’ equity and results from transactions with outsiders.
- Retained earnings represents stockholders’ equity earned by profitable operations and not paid out as dividends. This is internally generated stockholders’ equity and results from internal corporate decisions and earnings.
Stockholders may have four basic rights:
Vote. Stockholders participate in management by voting on corporate matters. This is the only way in which a stockholder can help to manage the corporation. Normally, each share of common stock carries one vote.
Dividends. Stockholders receive a proportionate part of any dividend. Each share of stock receives an equal dividend; for example, a shareholder who owns 1 percent of the total shares in the company receives 1 percent of any dividend.
Liquidation. Stockholders receive their proportionate share of any assets remaining after the corporation pays its debts and liquidates (goes out of business).
Preemption. Stockholders can maintain their proportionate ownership in the corporation. Suppose you own 10 percent of a corporation’s stock. If the corporation issues 250,000 new shares of stock, it must offer you the opportunity to buy 10 percent (25,000 shares) of the newly issued stock. Most states require that preemptive rights be specified in the corporate charter. For most companies, preemptive rights are the exception rather than the rule.
Classes of Stock
The most typical kind of stock that usually confers on the stockholder the rights to vote, to receive dividends, and to receive assets if the company liquidates.
Every corporation must issue common stock, which represents the basic ownership of the corporation. The real “owners” of the corporation are the common stockholders.
Stock that gives its owners certain advantages over common stockholders, such as the right to receive dividends before the common stockholders and the right to receive assets before the common stockholders if the corporation liquidates.
In addition to common stock, a corporation may also issue preferred stock, which gives its owners certain advantages over the owners of common stock.
- Most notably, preferred stockholders receive dividends before common stockholders.
- They also receive assets before common stockholders if the corporation liquidates.
- Corporations pay a fixed dividend on preferred stock, which is printed on the face of the preferred stock certificate.
- Investors usually buy preferred stock to earn those fixed dividends.
With these advantages, preferred stockholders take on less investment risk than common stockholders.
Par Value, Stated Value, and No-Par Stock
Par value is an arbitrary amount assigned by a company to a share of its stock.
Par value is arbitrary and is assigned when the organizers file the corporate charter with the state. There is no real “reason” for why par values vary. It is simply a choice made by the organizers of the corporation.
Stated value is an arbitrary amount similar to par value. Instead of being assigned when the corporate charter is filed, the stated value is assigned at a later date, such as when the company decides to issue stock.
No Par Value
A company can also issue stock that has no par (or stated) value, known as no-par stock.