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Common and Preferred Stock Financing

Prepared by: Terry Fegarty Seneca College

McGraw-Hill Ryerson

2003 2003 McGraw-Hill RyersonLimited McGraw-Hill Ryerson Limited

Chapter 17 - Outline

PPT 17-2

Stock The Voting Right Rights Offering Rights-on and Ex-rights Poison Pill Preferred Stock Provisions Associated with Preferred Stock Risk and Expected Return Summary and Conclusions
2003 McGraw-Hill Ryerson Limited

PPT 17-3

Common Stock

Common shareholders own the corporation and have ultimate control They have a residual (leftover) claim to all corporate income that is not paid out to others Common shareholders have the right to vote on all major issues, including election of the board of directors Practically, management controls the corporation on a daily basis Management is most sensitive to the holders of large blocks of shares,

such as the founding family, mutual funds, pension funds, insurance companies, trust companies
2003 McGraw-Hill Ryerson Limited

The Voting Right


PPT 17-4

assigning shareholders right to vote to another individual

Majority Voting:
all directors must be elected by at least 51% of the vote doesnt allow minority shareholders representation on the board of directors

Cumulative Voting:
a shareholders votes can all be used to elect 1 person allows minority shareholders representation on board

2003 McGraw-Hill Ryerson Limited

Rights Offering
Rights Offering:

PPT 17-5

gives current shareholders a first option to purchase new shares (called a preemptive right provision) allows existing shareholders the same amount of control they have initially shareholder receives 1 right for each share of stock owned

2003 McGraw-Hill Ryerson Limited

Rights-on and Ex-rights


PPT 17-6

if you buy the stock, you will also acquire a right toward a future purchase of the stock occurs when a rights offering is initially announced

when you buy the stock you no longer get a right toward future purchase of the stock occurs after a certain period of time

2003 McGraw-Hill Ryerson Limited

Figure 17-1

PPT 17-8

Time line during rights offering

2003 McGraw-Hill Ryerson Limited

PPT 17-9

Poison Pill
Poison Pill:
a rights offering made to existing shareholders of a company in order to make it more difficult for another company to acquire it allows existing shareholders the right to buy additional shares of the stock at a very low price makes hostile takeovers very expensive and unattractive often introduced by management to protect their own interests

2003 McGraw-Hill Ryerson Limited

Preferred Stock

PPT 17-10


a hybrid security combining characteristics of both debt and common stock has a fixed dividend that must be paid before dividends on common stock dividends are not tax deductible to a company provides the company with a balance in its capital structure primary purchasers are corporate investors, insurance companies, and pension funds
2003 McGraw-Hill Ryerson Limited

Beforetax and aftertax yields on corporate debentures and preferred shares

Before-tax debenture yield . . . . . . . . . . . . . Combined marginal tax rate (39%) . . . . . . . Aftertax debenture yield . . . . . . . . . . . . . . Before-tax preferred yield . . . . . . . . . . . . . . Combined marginal tax rate (24.08%) . . . . . Aftertax preferred yield . . . . . . . . . . . . . . . . 6.57 percent (2.56) 4.01 percent 5.34 percent (1.29) 4.05 percent

PPT 17-11

2003 McGraw-Hill Ryerson Limited

Provisions Associated with Preferred Stock

PPT 17-12

Cumulative Dividends: if not paid in one year, dividends accumulate and must be paid in total before common shareholders Conversion Feature: preferred stock may be converted into common stock at the option of the holder Call Feature: company has option to redeem stock Retractable Feature: investor has option to redeem stock Floating Rate Dividend: company adjusts dividend to market conditions
2003 McGraw-Hill Ryerson Limited


Table 17-1a

Features of alternative security issues

1. Ownership and control of the firm Common Stock Belongs to common shareholders through voting rights and residual claim to income Preferred Stock Limited rights when dividends are missed Bonds Limited rights under default in interest payments

2. Obligation to provide return 3. Claim to assets in bankruptcy 4. Cost of distribution


Must receive payment Contractual obligation before common shareholder Bondholders and creditors must be satisfied first Moderate Highest claim

Lowest claim of any security holder Highest


2003 McGraw-Hill Ryerson Limited


Table 17-1b

Features of alternative security issues

Common Stock
5. Risk-return trade-off Preferred Stock Moderate risk, moderate return Bonds Lowest risk, moderate return

Highest risk, highest return (at least in theory)

6. Tax status of payment by corporation 7. Tax status of payment to recipient

Not deductible

Not deductible

Tax deductible Cost = Interest payment (1 Tax rate)

Interest usually fully taxable

Dividend to another corporation is usually tax exempt Special tax treatment with dividend tax credit

Same as common stock

2003 McGraw-Hill Ryerson Limited

Figure 17-2

Risk and expected return for various security classes

Required rate of return


Common stock Subordinated debentures Senior unsecured debt

Secured debt

Long-term government securities Treasury bills (short term) Savings account

Preferred stock

Risk to investor
2003 McGraw-Hill Ryerson Limited

PPT 17-16

Summary and Conclusions



shareholders have a residual claim to company income Different classes of common shares may be entitled to different dividend amounts and voting rights

rights offering provides the common shareholder with a first option to buy new shares Poison pills provide for an extensive dilution of ownership in case of a hostile take-over Preferred stock is an intermediate security falling between bonds and common shares Dividends on Canadian shares are granted special tax credits. It is appropriate to compare aftertax yields on securities Long-run returns for securities tend to vary with the risk involved
2003 McGraw-Hill Ryerson Limited