When someone buys a share of stock in a company, they're basically buying ownership in the company; how much ownership depends on the number of shares owned and how many shares of stock the company has overall. Preferred and common stock both carry an ownership interest but may entitle the holder to different rights and privileges. Those with questions about the stock of a specific company should speak to a company representative.
While common and preferred stock have many general traits, note that companies can usually write their own rules for each type of stock. The company's controlling documents, such as the articles of incorporation or the corporate bylaws, may lay out both rights and obligations for each type of stock the company offers. Companies have a lot of choice in how they set their stock up, so the general rules about common and preferred stock may not apply to each individual company.
In a typical corporation, most of the shares offered are common stock. Common stock usually carries voting rights with it; the owner of the stock has the right to participate whenever shareholders are called upon to vote on significant company matters. For instance, common shareholders vote on each director elected to the board of directors, and the typical board cannot take drastic action affecting the company (such as a merger or change of form of the business) without holding a shareholder vote. Common shareholders typically have the right to receive dividends (return on their investment based on the company's profits) whenever the board decides to declare them.
Preferred stock is an ownership interest more interested in financial return than in control of the company. A typical preferred shareholder doesn't vote on the composition of the company's board or other matters; he just wants to receive his dividends. Preferred dividends don't fluctuate based on the company's profits; each preferred shareholder is entitled to a fixed amount at certain periods (so long as the company has the money.) If the board should not declare dividends for a length of time, however, the preferred shareholders usually gain the right to vote directors off the board. Note that a company may have many different classes of preferred stock, each with different rights and privileges.
Preference in Liquidation
The term "preferred" refers to a preferred shareholder's rights if the company should run out of money or decide to terminate its own existence. If the company liquidates, shareholders only receive repayment on their principal investment once all of the creditors and bondholders have been repaid. However, within the shareholder class, preferred shareholders will be repaid before common shareholders. This difference can be crucial when a company doesn't have enough money to pay back all of its investors; preferred shareholders may get their money back, while some common shareholders get nothing.
- "Corporations, Other Limited Liability Entities and Partnerships"; Thomas Lee Hazen and Jerry W. Markham; 2008
- Investor Guide: Common and Preferred Stock
Erika Johansen is a lifelong writer with a Master of Fine Arts from the Iowa Writers' Workshop and editorial experience in scholastic publication. She has written articles for various websites.