Business Finance - Chapter 17 - Common & Preferred Stock Financing

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Voting rights

Common stockholders may have different voting rights based on the class of stock they hold. Bondholders and preferred stockholders may only vote when a violation of their corporate agreement exists and a subsequent acceleration of their rights takes place.

Preferred stock

Entitled to receive a stipulated dividend and , generally, must receive the dividend before the payment of dividends to common stockholders. However, their right to annual dividends is not mandatory for the corporation, as is true of interest on debt, and the corporation may forgo preferred dividends when this is deemed necessary. Most corporations that issue preferred stock do so to achieve balance in the capital structure. It is a means of expanding the capital base of the firm without diluting the common stock ownership position or incurring contractual debt obligations.

Common stockholders

Investors who own the firm's common stock. Common stockholders are the residual owners of the firm. They may vote in the election of the board of directors and all other major issues. May cast their ballots as they see fit, or assign a proxy.

Cumulative voting

Makes it possible for minority shareholders to elect some of the directors. The provision for some minority interests on the board is important to those who, at times, wish to challenge the prerogatives of management.

Rights Offering

New shares are sold to existing shareholders Used by many US companies and are especially popular as a fund-raising method in Europe. Most rights offerings are successful in getting shareholders to exercise their rights to buy new shares When all the shares are not exercised by shareholders, the investment banker in charge of the offering exercises the rest and sells them in the open market.. The number of shares a shareholder can buy is conditional on the number of shares already owned, and there is a ratio of new shares to shares already owned. There is no standard ratio. Often the new shares are priced at a discount. The more the shares are underpriced (compared to market) the more likely it is that the rights will be exercised.

ex-rights

The first day that a buyer can purchase a security and not be entitled to receive any preemptive rights

Election of Board of Directors

The most important voting matter for stockholders. The board has primary responsibility for the stewardship of the corporation and may be held legally liable if illegal or imprudent decisions are made. The board members normally serve on a nuber of subcommittees, like the audit committee, the long range planning committee, and the salary and compensation committee.

rights-on

The situation in which the purchase of a share of common stock includes a right attached to the stock.

Poison pill

Used by a company to give shareholders certain rights in the event of takeover by another firm Most poison pills have a trigger point. When a potential buyer accumulates a given percentage of common stock, the other shareholders may receive rights to purchase additional shares from the company, generally at very low prices. Generally do not have to be voted on by shareholders to be put into place.

margin requirement

minimum deposits left with a stockbroker to be used as partial payment on other securities

Founders' Shares

stock owned by the firm's founders that enables them to maintain control over the company without having to own a majority of stock

Residual claim to income

the basic claim that common stockholders have to income that is not paid out to creditors or preferred stockholders. True whether it's paid out in dividends or retained in the corporation

American Depository Receipts (ADRs)

"Certificates" created by organizations such as banks; represent ownership in stocks of foreign companies that are held in trust by a bank located in the country where the stock is traded. The bank has purchased shares in a foreign company, placed the shares in a trust, and issued depository receipts against the trust. Advantages: - annual reports and financial statements are presented in English according to GAAP - dividends are paid in US dollars and are more easily collected than if the actual shares of the foreign stock were owned. - considered to be more liquid, less expensive, and easier to trade than buying foreign companies' stock directly Disadvantages - the foreign currency risk can mean the exchange rate will cause an eroded return - information lag can occur as reports are translated

If the number of minority shares is known and we wish to determine he number of directors that can be elected, this formula is used:

(Shares owned -1) x (total number of directors to be elected +1) / (total number of shares outstanding) If the formula yields an uneven number of directors (ie: 3.3 or 3.8), always round down to the nearest whole number (ie: 3)

Desirable features of rights offerings

1. Protects the stockholders' current position in regard to voting rights and claims to earnings. 2. Gives the firm a built-in market for new security issues (making distribution costs lower than under a straight public issue) 3. May generate more interest in the market than a straight public issue 4. Stock purchased through a rights offering carries lower margin requirements.

preemptive right

A provision in the corporate charter or bylaws that gives common stockholders the right to purchase on a pro rata basis new issues of common stock (or convertible securities). Stockholder's right to maintain his or her proportionate ownership in the corporation.

How does cumulative voting work?

A stockholder gets one vote for each share of stock he owns, times one vote for each director to be elected. The stockholder may then accumulate votes in favor of a specified number of directors. Assume there are 10,000 shares outstanding, your own 1,001, and nine directors are to be elected. Your total votes under a cumulative election are: # of shares owned 1,001 # of directors to be elected 9 # of votes 9,001 To determine the number of shares needed to elect a given number of directors under cumulative voting, the following formula is used: (total shares outstanding x number of directors desired / (total number of directors to be elected + 1) + 1)

Proxy

Agent, substitute, person authorized to act on behalf of another. Gives the power to cast the vote to management or some outside contesting group.

Majority voting

Any group of stockholders owning over 50 percent of the common stock may elect all of the directors.

Monetary Value of a Right

Anything that contributes toward the privilege of purchasing a considerably higher priced stock for $30 per share must have some market vale. Nine old shares sold at $40/share, or $360. Now one new share will be introduced for $30. Not the total market value for 10 shares is $390. After the rights offering has been completed, the average value of a share is theoretically $39. $360+30=$390 $390/10=$39 The rights offering entitles the holder to buy a stock that should carry a value of $39 (after the transactions have been completed) for $30. With a differential between the anticipated price and the subscription price of $9 ($39-$30) and nine rights required to participate in the purchase of one share, the value of a right in this case is $1 Average value of one share $39 Subscription price 30 Differential $ 9 Rights required to buy 1 share 9 Value of a right $ 1


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