In the following paragraphs, a comprehensive insight into the difference between preferred stock and common stock has been given. To know more, read on.
Before we discuss the comparison between preferred stock and common stock, stating the conception of stock and joint stock companies is an absolute essential. This type of business organizations which came into being in the industrial revolution era, have made a significant impact and impression on commerce, economics and businesses world-wide.
The big impact on the society was that the common man was able to freely and securely contribute to capital of a business organization, and thus reap the benefits. In order to get the gist of the comparison of ‘preferred stock vs. common stock’ let’s keep the explanation simple, and free from technical terms.
Joint Stock Companies
In the industrial revolution era, expanding business horizons called for larger capitals. Traditional business organizations, such as the sole trading concerns, partnership firms and family business were not able to pool in the sufficient capital. A via-media to the problem was Chattered Companies that were sanctioned by the European royalty, which enabled larger volumes of traders and entrepreneurs to pool in capital. However, even these type of companies had some drawbacks.
In the year 1844, the Joint Stock Companies Act was passed in the Parliament of United Kingdom. This piece of legislation is the foundation of all ‘companies’ and ‘corporations’ all around the world. The concept was simple enough, a promoter would conceive and commence a business, and would then issue a prospectus to the people though a newspaper or an advertisement stating the need for certain capital.
People then would contribute money to a ‘common stock’ in very small denominations. The denominations were known as ‘shares’, thus making the people ‘share holders’. The total profit of the company is distributed among all shareholders, and is known as a ‘dividend’. The total management of the company would be democratic, and the shareholders could elect people among themselves to run the business.
The promoter would have a small say in the matters. This basic structure and mechanism of joint stock companies has remained the same. Today after considerable evolution and a widespread use of such business organizations, some regional names have evolved, such as ‘Corporation’ in most of the North American nations, ‘LTD’ companies in many common wealth nations, including Great Britain or simply ‘companies’ in some nations.
Common Stock Vs. Preferred Stock
As mentioned above, the principal capital of companies is raised with the help of share holders, who contribute to the common stock. Shares which are often referred to as ‘securities’ or even ‘instruments’, and are treated as assets. These shares can be classified into two principal categories, namely, preferred stock and common stock. This following paragraph will give you the answer to the query ‘what is the difference between preferred stock and common stock’.
The preferred stock holders get a fixed rate of dividend every year, consistently. On the other hand the common stock holders get a fluctuating dividend which, varies as per the profits of the company. The second point of comparison is the democratic management of the company. To deal with the affairs of the company, the holders of common stock can vote people to the management. The holders of the preferred stock however, do not have any kind of voting right, and are barred from controlling the management of the company.
It must be noted that voting right does not just include voting the management of the company, but it also includes some other aspects such as voting on major decisions of the company. The third common point of comparison is the repayment of capital in the due course of winding up of the company or the dissolution of the company. The preferential stock holders get back all their capital when the company is dissolved. The preferential capital is basically the capital amount that is repaid first, and is then followed by other repayments.
The next point of comparison is the stock market value of the shares. Shares can be freely traded through stock exchanges. The cost of preferential shares in the market is usually quite low owing to the fact these shares do not have voting rights. Common shares in contrast have greater market value.
Overall, both the types of stock are quite advantageous. The preferred stock is much better for regular income, and common stock is better for stock trading and voting on the company management. Please note that some facts may differ, as there is a significant difference in the laws, that govern the working of the companies from nation to nation.