Additional Notes for Chapter 14

Ownership of the Corporation

 A corporation is owned by its common stockholders.

 What do we mean when we say that the stockholders own the corporation?
 First, the stockholders are entitled to whatever profits are left over after the
lenders have received their entitlement. Usually the company pays out part
of these profits as dividends and plows back the remainder into new
investments.
 Second, shareholders have the ultimate control over how the company is
run. The company needs shareholder agreement to increase the authorized
capital or to merge with another company. On most other matters,
shareholders control boils down to the right to vote on appointments to the
board of directors.
 The board of directors usually consists of the company’s top management
as well as outside directors, who are not employed by the firm. It appoints
and oversees the management of the firm and meets to vote on such
matters as a new share issue or the payment of a dividend.
 Most of the time the board will go along with the management, but in
crises situations it can be very independent.

Voting Procedures

 Majority Voting:
In most companies stockholders elect directors by a system of majority
voting. In this case each director is voted on separately, and stockholders
can cast one vote for each share they own.
Example: Suppose you have 100 shares and 5 directors will be elected. You
can cast a maximum of 100 votes for any one candidate.

 Cumulative Voting:
 In this case the directors are voted on jointly, and the stockholders can, if
they choose, cast all their votes for just one candidate.
Example: Suppose you have 100 shares and 5 directors will be elected. You
therefore have a total of 5 * 100 = 500 votes.

 Cumulative voting makes it easier for a minority group of the

stockholders to elect a director representing their interests.
 On many issues a simple majority of the votes cast is enough to carry
the day, but there are some decisions that require a “supermajority”
of, say, 75% of those eligible to vote. e.g. a merger.

Preferred Stock

 Usually when investors talk about equity or stock, they are reffering
to common stock. But companies may also issue preferred stock, and
this too is part of the company’s equity.
 The sum of a corporation’s common equity and preferred stock is
known as its net worth.
 Like debt, preferred stock promises a series of fixed payments to the
investor and with relatively rare exceptions preferred dividends are
paid in full and on time.
 Nevertheless, preferred stock is legally an equity security because
payment of a preferred dividend is within the discretion of the
directors.
 The only obligation is that no dividends can be paid on the common
stock until the preferred dividend has benn paid.
 Preferred stock owners have no voting power (they can only vote
under special situations).
 Preferred stock has a particular attraction for banks, for regulators
allow banks lump preferred in with common stock when calculating
whether they have sufficient equity capital.
 Like common stock dividends, preferred dividends are paid from
after-tax income.
 However, preferred stock does have one tax advantage. If one
corporation buys another’s stock (common or preferred), only 30% of
the dividends it receives is taxed.
 This is most important for preferred, for which returns are dominated
by dividends rather than capital gains.
Example: Suppose that your firm has surplus cash to invest. If it buys
a bond, the interest will be taxed at the company’s tax rate of 35%. If
it buys a preferred share, it owns an asset like a bond, but the
effective tax rate is only 30% of 35%, 0.30 * 0.35 = 0.105%, or 10.5%.
 This is why most preferred shares are held by corporations.
 One problem with preferred stock that pays a fixed dividend is that
the preferred’s market prices go up and down as interest rates
change (because present values fall when rates rise).
 The solution to this problem is the floating-rate preferred.
 If you own floating-rate preferred, you know that any change in
interest rates will be counterbalanced by a change in the dividend
payment, so the value of your investment is protected.