The Stock Market (part B)
by
Charles Lamson
The Anatomy of Stocks
Firms issue shares of stock when they need to raise long-term financial capital usually for investment spending. If a corporation is publicly held, shares of stock are sold to the public. A share of stock represents equity in a corporation and entitles the owner to a share of the corporation's profits. The stock may be preferred stock or common stock. Owners of preferred stock receive a fixed dividend to which they are entitled before owners of common stock can receive anything. The fixed dividend is similar to the interest payment that a bondholder receives. However, dividends must be paid to preferred stockholders only if the corporation earns a profit, whereas the corporation is liable for interest payments under all circumstances. In addition, interest payments to bondholders are tax write-offs for the corporations; dividend payments to preferred stockholders are not.
Common stockholders receive a variable dividend after preferred stockholders have been paid and retained earnings have been set aside. Retained earnings are profits not distributed to stockholders that are usually used to fund investment projects. The current trend among many corporations is to forgo paying dividends to common stockholders. In this case, stockholders benefit from increases in the stock's price generated by putting the earnings back into the company or using the earnings to purchase the company's own stock. If a company buys back its own stock and does not resell it, the stock is retired. After shares of stock are retired, the remaining outstanding shares tend to appreciate in value. Common stockholders have voting rights within the firm, whereas preferred stockholders do not. Stockholders who own only a minuscule share of the outstanding stock of a firm do not usually exercise voting rights.
Investment bankers usually market new shares of stocks or securities. One or more securities firms design and market the new securities offering. Sometimes, employees and individuals may purchase new shares of stocks directly from the company, thus bypassing investment banks. Stocks represent liquid claims because the shares can usually be sold relatively easily in secondary markets. Previously issued shares of stock are traded either on organized exchanges or over the counter. The marketing of newly issued shares represents primary market activity, while the purchase or sale of previously issued securities represents secondary market activity. The Securities and Exchange Commission (SEC) has extensive authority to regulate secondary market activities.
All companies that issue publicly traded shares of stock are regulated by the SEC that was created by the Securities and Exchange Act of 1934. The SEC has broad disclosure requirements to protect investors by requiring companies to file numerous reports detailing the financial condition of the company, information about key personnel, and any changes that would be important to stockholders.
Stock Offerings
An initial public offering (IPO) is when a corporation issues stock publicly for the first time. A secondary stock offering is an offering of newly issued shares by a firm that already has outstanding publicly held shares. To bring new shares to the market, a corporation must register the new issue with the SEC. Since 1982, the SEC has allowed corporations to register securities without immediately issuing them through a procedure called shelf registration. Shelf registration permits a company to register a quantity of securities and sell them over a two-year period rather than at the time the shares are registered. This avoids the costs in time and money of several registration processes and also allows the firm to respond quickly to advantageous market conditions.
*SOURCE: THE FINANCIAL SYSTEM & THE ECONOMY, 3RD ED., 2003, MAUREEN BURTON & RAY LOMBRA, 378-383*
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