Characteristics of Common Stock

The two most important characteristics of common stock as an investment are its residual claim and limited liability features.

Residual claim means that stockholders are the last in line of all those who have a claim on the assets and income of the corporation. In a liquidation of the firm's assets the shareholders have a claim to what is left after all other claimants such as the tax authorities, employees, suppliers, bondholders, and other creditors have been paid. For a firm not in liquidation, shareholders have claim to the part of operating income left over after interest and taxes have been paid. Management can either pay this residual as cash dividends to shareholders or reinvest it in the business to increase the value of the shares.

2 A corporation sometimes issues two classes of common stock, one bearing the right to vote, the other not. Because of its restricted rights, the nonvoting stock might sell for a lower price.

CHAPTER 2 Markets and Instruments

Figure 2.10 Stock market listings.

NEW YORK STOCK EXCHANGE COMPOSITE TRANSACTIONS

52 WEEKS

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Source: The Wall Street Journal, October 22, 1997. Reprinted by permission of The Wall Street Journal, © 1997 Dow Jones & Company, Inc. All Rights Reserved Worldwide.

Limited liability means that the most shareholders can lose in the event of failure of the corporation is their original investment. Unlike owners of unincorporated businesses, whose creditors can lay claim to the personal assets of the owner (house, car, furniture), corporate shareholders may at worst have worthless stock. They are not personally liable for the firm's obligations.

CONCEPT CHECK ^ QUESTION 4

a. If you buy 100 shares of IBM stock, to what are you entitled?

b. What is the most money you can make on this investment over the next year?

c. If you pay $50 per share, what is the most money you could lose over the year?

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