Let’s say you just bought stock in AT&T. As a part owner of the company, can you call your long-distance relatives for free during the holidays? And never mind the dividends, why is it that Apple shareholders don’t receive free iPods? While these perks may be unlikely, they do raise an excellent question: What are your rights as a shareholder?
The Rules of Absolute Priority
Every company has a pecking order of rights that accompanies the three main classes of securities: common stock, bonds, and preferred stock. To understand the priority of each security, let’s examine company bankruptcy. Unfortunately, in this case, common shareholders are the corporate equivalent of a vulture that eats only after the lions and hyenas have had their share. Because creditors put up the original money to get the company started, they’re first in line for the company’s assets. Next come bondholders, preferred shareholders, and finally the common shareholders.
Moreover, company charters typically limit voting privileges to the common stockholders, while preferred stockholders receive dividends before common stockholders. Bondholders’ rights are determined differently, because their payments and privileges are governed by the tenets of their contract with the issuer.
Risks and Rewards
All of this might sound bad for common shareholders; however, they’re still part owners of the business, and that means that when the corporation turns a profit they’ll gain from it. Furthermore, the liquidation described above is logical: Because shareholders receive next to nothing if a corporation goes bankrupt, they also have a greater reward potential if the company succeeds. The price of preferred stock, on the other hand, tends to fluctuate less.
Common Shareholders’ Six Main Rights:
- Voting Power. This includes director elections and proposals for fundamental changes that affect the company, such as mergers and acquisition or liquidation.
- Right to Increased Share Values. While bondholders and preferred shareholders are paid first when a company goes bankrupt, it’s the common shareholders who really thrive when a company turns a profit.
- Right to Transfer Ownership. This right gives shareholders the freedom to trade their stock on an exchange. If this doesn’t thrill you, consider other investments like real estate. However, it is important to remember: If you own property, it can take months to convert your investment into cash. But because stocks are so liquid, you can move your money around at will.
- Dividend Entitlement. While common shareholders don’t have a say in what percentage of profits should be paid out in the form of dividends, when they are declared common shareholders are entitled to receive their share.
- Right to Inspect Corporate Books and Records. This right isn’t as important nowadays because public companies are required to make their financials public; nevertheless, it can be important for shareholders of private companies.
- Suing for Wrongful Acts. This right is usually exercised by a class-action lawsuit. Examples include when a company significantly overstates its earnings, thereby giving shareholders and investors an erroneous view of its financial health.
Shareholder Rights Plan
These plans define shareholder rights for a given company and are usually accessible in the investor relations section of its corporate Web site or by contacting the company directly. The plans give the company’s board of directors the power to protect shareholder interests in the event of an attempted takeover. Should another person or firm acquire a controlling interest of outstanding shares, the shareholder rights plan can be exercised.
As a shareholder and an informed investor, knowing your rights is essential. Those who fully understand their rights are much less susceptible to additional risks.