Page 186 - Encyclopedia of Business and Finance

eobf_C 7/5/06 2:57 PM Page 163

Corporations

Cumulative voting offers some protection for smaller Occasionally preferred stock is given the right to
stockholders. “participate” with common stock in being granted divi-
The market value of common stock tends to fluctu- dends above a stated value. For example, assume the board
ate more than that of preferred stock. of directors declares a regular preferred stock dividend at
$3 per share and a common stock dividend at $13 per
Preferred Stock. Preferred stockholders are not ordinarily share. With participating rights, it would have been stip-
granted the voting rights given to common stockholders. ulated that preferred stockholders would receive $1 per
share more for every additional $5 given to common
They cannot participate in elections for members of the
board of directors or in major decisions of the corpora- stockholders.
tion. If a corporation closes down its operation, preferred
However, preferred stockholders are almost always stockholders have prior claim over common stockholders
given prior rights over common stockholders in the mat- upon dissolution of the assets. A sufficient amount of the
ter of dividends. corporation’s assets would need to be turned over to the
preferred stockholders before common stockholders could
Dividends for preferred stockholders are often stated
in advance and do not tend to fluctuate as much as those claim any part of the assets. In practice, however, assets of
a closed-down corporation are rarely sufficient to pay off
for common stock. Preferred dividends may be stated as a
the preferred shareholders in full.
percentage of par value or as a dollar amount per share.
However, preferred dividends are not guaranteed in
RELATED FORMS OF BUSINESS
the same sense as is bond interest. Neither preferred nor
OWNERSHIP
common stock dividends can be paid without approval of
the board of directors. Boards may “skip” declaring divi- Five types of business entities have regulations similar to
dends if the directors feel the financial situation so war- those of corporations.
rants.
Preferred stock is often “cumulative.” With this pro- Professional Corporations. Professional corporations,
vision, a preferred stock dividend that is not declared or organized under corporation laws of their respective
paid is considered to be “owed.” As long as the preferred states, involve incorporation by persons engaged in profes-
dividend is “owed,” no common stock dividend may ordi- sional practice, such as medical doctors, lawyers, and
narily be declared or paid. But even if the preferred stock architects. They are granted limited liability against claims
is not cumulative, a frequently applied policy is that com- from their clients, except for malpractice.
mon stock dividends cannot be declared as long as the
preferred dividends are “in arrears.” Not-for-Profit Corporations. Not-for-profit corpora-
Sometimes preferred stock is “convertible.” Share- tions, formed under the nonprofit laws of their respective
holders who own convertible preferred stock may, at a states, have members instead of stockholders. Any income
price announced when the stock is purchased, turn in made cannot be distributed to the members.
their preferred stock and receive common stock in its Some apply to the Internal Revenue Service for tax-
place. Assume, for example, that an investor purchases exempt status, becoming 501(c)(3) organizations, which
preferred stock at $36.50 per share. The stock is convert- permits donor gifts to be declared tax-deductible.
ible four years from its issuance at a ratio of 3:1; that is,
three shares of preferred stock can be traded at the share- Closed Corporations. Closed corporations, not permitted
holder’s option for one share of common stock. At the 3:l by statute in all states, limit shareholders to fifty. They
ratio, after discounting any related transfer costs, the pre- permit the firm to operate informally either by eliminat-
ferred stockholder would find it profitable to convert if ing the board of directors or curtailing its authority.
the common stock value rises above $109.50 per share Closed corporations also restrict transferability of the
($36.50 ¥ 3). owners’ shares of stock.
Preferred stock may be “callable.” At the option of the
corporation, callable preferred stock may be surrendered Limited-Liability Companies. Limited-liability compa-
to the corporation, usually at a price a little above par nies enjoy the benefits of limited liability while being
value (or a stated value). If the stated value is $50, the taxed like a general partnership. Owners’ net income is
callable price on or after a specified date might be $51.25. taxed at an individual personal rate rather than at the rate
If the stock’s market value rises to, say, $55, it might be of a corporation (taxation of both corporate net income
profitable for the corporation to call for its surrender. and dividends).

ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION 163