What Are Ordinary Shares and How Do They Work?

Investing in a company often means buying shares, but not all shares are the same. Ordinary shares, or common stock, are the most widely held type of equity in publicly traded companies. They offer potential rewards through dividends and capital appreciation but also come with risks, particularly during financial downturns.

Equity Ownership

Owning ordinary shares means holding a portion of a company, with the size of that stake determined by the number of shares owned relative to the total outstanding shares. This ownership grants shareholders a claim on the company’s assets and earnings, though the value fluctuates based on market conditions and company performance. If a business grows and becomes more profitable, its share price typically rises, benefiting investors. Conversely, if the company struggles, the stock price may decline, reducing the value of an investor’s holdings.

Shareholders may also face tax implications when selling shares at a profit. In the U.S., long-term capital gains—on shares held for more than a year—are taxed at rates ranging from 0% to 20% in 2024, depending on income level. Short-term gains, from shares sold within a year, are taxed as ordinary income, with rates as high as 37%. Investors should also consider transaction costs, such as brokerage fees, which can affect overall returns.

Dividend Entitlements

Ordinary shareholders may receive dividends, which are distributions of a company’s profits. However, these payments are not guaranteed. Companies must generate sufficient earnings and then decide whether to allocate funds for dividends or reinvest in growth. Unlike bonds, which offer fixed interest payments, dividends on ordinary shares can vary.

Before issuing dividends, a company’s board of directors must declare them, specifying the amount and payment schedule. This process involves key dates: the declaration date, when the board announces the dividend; the ex-dividend date, which determines shareholder eligibility; the record date, when the company finalizes the list of eligible shareholders; and the payment date, when funds are distributed. Investors who buy shares on or after the ex-dividend date will not receive the upcoming dividend.

Dividend policies differ across industries. Established firms with stable cash flows, such as utilities and consumer goods companies, often pay consistent dividends. In contrast, high-growth technology firms may reinvest profits instead. Some companies follow progressive dividend policies, increasing payouts over time, while others issue special dividends in particularly profitable years. Investors should assess a company’s dividend history and payout ratio to gauge the sustainability of future payments.

Voting Rights

Ordinary shareholders influence corporate decision-making through voting rights, primarily in board elections. Companies typically hold annual general meetings (AGMs) where shareholders vote in person or by proxy, authorizing someone else to vote on their behalf.

Voting structures vary. Many companies operate on a one-share, one-vote basis, giving larger shareholders more influence. Others, such as Meta Platforms and Alphabet, use dual-class share structures, where certain shares carry enhanced voting power, often benefiting founders or early investors.

Beyond board elections, shareholders may vote on executive compensation, stock issuance plans, and mergers. They can also submit shareholder proposals, which, while often non-binding, can influence corporate policies on environmental, social, and governance (ESG) issues. Institutional investors, such as pension and mutual funds, frequently use their voting power to push for governance changes.

Position in Liquidation

If a company goes bankrupt and enters liquidation, the repayment of stakeholders follows a legally defined hierarchy. Ordinary shareholders are last in line, meaning they only receive funds if all other obligations have been met.

Secured creditors, such as banks with collateralized loans, are paid first, followed by unsecured creditors like bondholders and suppliers. Preferred shareholders, who have a higher claim on assets, are next in priority. If any funds remain after these obligations, ordinary shareholders receive the remainder. However, in many bankruptcies, liabilities exceed assets, leaving little or nothing for common stockholders. The collapse of Lehman Brothers in 2008 demonstrated how equity holders often walk away with nothing, while secured creditors recover a portion of their investments.

Share Issuances

Companies issue ordinary shares to raise capital, either during an initial public offering (IPO) or through subsequent offerings. The number of shares issued affects ownership distribution and can impact stock prices. When new shares enter the market, existing shareholders may experience dilution, meaning their ownership percentage decreases unless they buy additional shares.

Public companies may conduct secondary offerings to fund expansion, acquisitions, or debt reduction. These offerings can be dilutive, increasing the total share count and reducing earnings per share (EPS), or non-dilutive, where existing shareholders sell their holdings without affecting the company’s capital structure.

Some firms also issue shares through stock-based compensation programs, granting employees equity rather than cash. While this aligns employee interests with company performance, excessive stock issuance can erode shareholder value over time.

Distinction from Preferred Shares

Ordinary shares differ from preferred shares in dividend payments, voting rights, and risk exposure. Preferred shareholders receive fixed dividends, often at a higher rate than ordinary shareholders, and these payments take precedence over common stock dividends. This makes preferred shares attractive to income-focused investors seeking more predictable returns. However, preferred shareholders typically do not have voting rights, limiting their influence over corporate decisions.

In terms of risk, preferred shares rank between debt and equity in a company’s capital structure. While they have a higher claim on assets than ordinary shares in liquidation, they still fall behind bondholders and other creditors. Some preferred shares include features such as convertibility, allowing holders to exchange them for ordinary shares under specific conditions, or callability, enabling the company to repurchase them at a predetermined price. These characteristics make preferred shares a hybrid investment, blending elements of fixed income and equity.