COMMON AND PREFERRED FINANCING

Characteristics of Common and Preferred stock and the rights pertaining to the ownership.

Common Stock and Common Stockholders

A. Although management controls the corporation on a daily basis, ultimate control of the firm
resides in the hands of the stockholders.
B. Management has become increasingly sensitive to the growing institutional ownership of
common stock. Mutual funds, pension funds, insurance companies and bank trust accounts are
examples of financial institutions that in combination own a large percentage of many leasing
corporation.
C. Common stockholders have a residual claim on the income stream; the amount remaining after
creditors and preferred stockholders have been satisfied belongs to the owners ( common
stockholders ) whether paid in dividend or retained.
D. A corporation may have several classes of common stock that differ in regard to voting rights
and claim on the earnings stream.
E. Owners of common stock have the right to vote on all major issues including election of the
board of directors.
1. Majority voting – holders of majority of stock can elect all direcetors.
2. In some firms different classes of stick are entitled to elect a specified percentage of the
board of directors.
3. Cumulative voting – possible for minority stockholders ( own less than 50 percent of stock )
to elect some of the directors.
a. The stockholder can cast one vote for each share of stock own times the number of
directors to be elected.
b. The following formula may be employed to determine the number of shares needed to
elect a given number of directors under cumulative voting.

Share required = Number of directors desired X Total number of shares outstanding +1

Total number of directors to be elected + 1
4. The stockholder may have the right to maintain his percentage of ownership, voting power,
and claim to earnings through the preemptive right provision which requires that existing
stockholders be given the first option to purchase new shares.
5. Financing through rights offerings
1. Even if the preemptive right provision is not required, the corporation may finance
through a rights offering.
2. Each stockholder receives one right for each share of stock owned, and is allowed to buy
new shares of stock at a reduced price ( below market value ) plus the required number
of rights/share.
3. The number of rights required to purchase a new share equals the ratio of shares
outstanding to the new shares issues.
Number of rights required to purchase one new share = Number of shares outstanding
Number of shares to be issued.
 4. Rights have market value since they entitle the holder to purchase shares of stock at less
than market price.
a. Initially, after the rights offering announcement, stock trades “rights-on”. The
formula for the value of a right during the rights-on period is
Mo-S
R=N+1
Where : Mo = Market value of stock, rights-on
S = Subscription price
N = number of rights required to purchase a new share of stock
b. After a certain period, theright no longer trades with the stock but may be bought
and sold separately. On the “ex-rights” date the stock price falls by the theoretical
value of a right. The ex-rights value of a right is:
Me – S
R= N
Where: Me = Market value of stock, ex-rights
5. Existing stockholders usually do not have a monetary gain from a rights offering. The
gain from purchasing shares at less than market price is eliminated by dilution of
previously owned shares.
6. A stockholder has three options when presented with a rights offering.
a. Exercise the rights; no net gain or loss
b. Sell the rights; no net gain or loss
c. Allow the rights to lapse; a loss will be incurred due to the dilution of existing shares
that is not offset by value of unsold or unexercised rights.
7. Desirable features of rights offerings
a. Protects stockholders’ voting position and claim on earnings
b. Existing stockholders provide a built-in market for new issues; distribution costs are
lower
c. May create more interest in stock than a straight offering
d. Lower margin requirement
II. Preferred Stock Financing
A. Characteristics of Preferred Stock
1. Stipulated dividends must be paid before dividends on common stock but are not
guaranteed or required.
2. Dividends are not tax-deductible.
B. Preferred stock contributes to capital structure balance by expanding the capital base
without diluting common stock or incurring contractual obligations.
C. Primary purchasers of preferred stock are corporate investors, insurance companies and
pension funds primarily because 85 % of dividend income received by corporations is
exempt from taxation whrereas interest received is fully taxable.
D. Provisions associated with preferred stock
1. Cumulative dividents
2. Conversion feature
3. Call feature
4. Participation provision
5. Floating rate
6. Par Value