What Are Two Characteristics of Common Stock?

Common stock represents a fundamental form of ownership within a company. Purchasing common stock grants a fractional ownership interest in the corporation, providing a claim on a portion of the company’s assets and earnings. This security distinguishes itself through specific characteristics that define the rights and potential returns of its holders.

Voting Rights in Common Stock

One defining characteristic of common stock is the voting rights it typically confers upon shareholders. These rights empower common stockholders to influence significant corporate decisions and participate in the company’s governance. Shareholders commonly vote on matters such as the election of the board of directors.

Shareholders also have a voice in major corporate actions, including proposed mergers, acquisitions, or substantial changes to company policy. The general standard for common stock is often “one share, one vote.” This allows investors with a larger stake in the company to have a proportionally greater say in these decisions.

In contrast, other types of stock, such as preferred stock, generally do not carry voting rights. This distinction highlights how common stock provides its holders with a direct mechanism to express their views on the company’s future and hold management accountable.

Residual Claim on Company Assets and Earnings

Common stockholders hold a residual claim on a company’s assets and earnings, meaning they are last in line during liquidation. This position implies that common shareholders are paid only after all creditors, such as bondholders and banks, and preferred stockholders have received their due. Consequently, common shareholders bear the highest financial risk if the company faces bankruptcy or liquidation, as assets may not remain after prior claims are settled.

Despite this higher risk, common stock offers significant upside potential through capital appreciation. If the company performs well and its value grows, the price of its common stock can increase without a fixed limit, providing substantial gains. Dividends, which are distributions of a company’s profits, also factor into potential returns. However, these dividends are not guaranteed and are paid at the discretion of the company’s board of directors, varying based on profitability and financial health.

This differs from preferred stock, which typically offers fixed dividend payments that are often prioritized over common stock dividends. The combination of being last in line during liquidation and having variable dividends means common stock carries more risk. This increased risk is directly linked to the potential for greater financial rewards through capital appreciation, creating a balance between the risk undertaken and the potential for higher returns.