For a successful company, the rights of stockholders and bondholders rarely come into conflict. Stockholders are owners of the company and have the right and obligation to vote for directors as well as certain initiatives brought to a vote of the stockholders. Both bondholders and stockholders have the right to receive company financial information. However, bondholders hold first rights to the distribution of assets if the company goes through bankruptcy. This is one example of where the rights of stockholders and bondholders are at odds.
Stockholders can use their voting power to bring initiatives to a vote of all stockholders. In doing this, the stockholders may remove management that opposes dividends in favor of management that supports large dividend payouts to stockholders. This may weaken the financial strength of the company and put bondholders at risk of lower values on their bonds and potential default on their interest payments.
Stockholders also have the right, as owners, to sell their shares to corporate raiders who want to do a leveraged buyout on the firm. A leveraged buyout also puts bondholders at risk because it normally results in selling off assets of the firm, lowering the company's financial strength. It may also result in a managed bankruptcy. Although bondholders have first rights to the proceeds of asset sales in the event of bankruptcy, these proceeds are not always enough to cash out the bondholders at the price they paid plus interest.
Companies can issue different classes of common stock. It's not unusual for there to be a class of voting stock and a class of non-voting stock, both trading on the public markets. The rights of shareholders depend on the specific company's charter and the rules of the state in which the company is incorporated. Most companies provide the standard rights to their stockholders, but an examination of the description of shareholders' rights found in the issue prospectus or the company charter are key investor due-diligence tasks — particularly if there is any doubt that the shareholders' rights are unusual.
Bondholders are creditors of the company. Their rights are spelled out in the bond indenture, which can be found in the issuing prospectus. While bondholders have first call on the proceeds of liquidation, some bondholders have senior rights to this money. First mortgage bonds rank senior in rights to debentures and any subordinated debt. As creditors, bondholders can make demands on a company approaching, or in, bankruptcy — particularly when the matter goes to court.
- Comstock/Comstock/Getty Images