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Lecture 5

FINA601 Lecture Notes - Lecture 5: Cumulative Voting, Preferred Stock, High-Yield Debt

21 pages81 viewsSummer 2018

Department
FINA
Course Code
FINA601
Professor
Ivan
Lecture
5

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Week 5 Lecture 5 Chapter 15: Long-Term Financing
Some Features of Common Stock (15.1)
The term common stock means different things to different people, but it is usually
applied to stock that has no special preference either in receiving dividends or in
bankruptcy
Shareholder Rights
A corporation’s shareholders elect directors who, in turn, hire management to carry
out their directives. Shareholders, therefore, control the corporation through the right
to elect the directors. Generally, only shareholders have this right - Directors are
elected each year at an annual meeting
Directors are elected at an annual shareholders’ meeting by a vote of the holders of a
majority of shares who are present and entitled to vote. However, the exact
mechanism for electing directors differs across companies. The most important
difference is whether shares must be voted cumulatively or voted straight.
The effect of cumulative (increasing by one addition after another) voting is to allow
minority participation - If cumulative voting is permitted, the total number of votes that
each shareholder may cast is determined first. This is usually calculated as the
number of shares (owned or controlled) multiplied by the number of directors to be
elected.
With cumulative voting, the directors are elected all at once. However, with straight
voting, the directors are elected one at a time
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Proxy Voting
A proxy is the grant of authority by a shareholder to someone else to vote her shares.
For convenience, much of the voting in large public corporations is actually done by
proxy
Obviously, management wants to accumulate as many proxies as possible.
However, an “outside” group of shareholders can try to obtain proxies in an attempt
to replace management by electing enough directors. The resulting battle is called a
proxy fight
Classes of Stock
Some firms have more than one class of common stock. Often, the classes are
created with unequal voting rights.
Example: Google, the Web search company, which only recently became publicly owned.
Google initially created two classes of common stock, A and B. The Class A shares are held
by the public, and each share has one vote. The Class B shares are held by company
insiders, and each Class B share has 10 votes. Then, in 2014, the company had a stock split
of its Class B shares, creating Class C shares, which have no vote at all. As a result,
Google’s founders and managers control the company.
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Other Rights
The value of a share of common stock in a corporation is directly related to the general rights
of shareholders. In addition to the right to vote for directors, shareholders usually have the
following rights:
1. The right to share proportionally in dividends
2. The right to share proportionally in assets remaining after liabilities have been paid in
a liquidation
3. The right to vote on stockholder matters of great importance, such as a merger
Voting usually occurs at an annual meeting or a special meeting
Corporations sometimes give a pre-emptive (It is done before other people can act,
especially to prevent them from doing something else) right to their stockholders.
A pre-emptive right forces a company to sell stock to its existing stockholders before offering
the stock to the general public. The right lets each stockholder protect his proportionate
(corresponding in size or amount to something else) ownership in the corporation.
Dividends
Dividends are paid out of the corporation’s after-tax cash flow. They are not business
expenses and are not deductible for corporate tax purposes.
Unless a dividend is declared by the board of directors of a corporation, it is not a
liability of the corporation. A corporation cannot default on an undeclared dividend.
As a consequence, corporations cannot become bankrupt because of nonpayment of
dividends. The amount of the dividend and even whether it is paid are decisions
based on the business judgment of the board of directors.
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