Common shares represent ownership and voting rights within a firm. In essence, common shares represent control of a firm. The control and profit of a firm is divided amongst shareholders in proportion to the amount of shares they own. The more shareholders a firm has, the greater the division of profit and control.
Shareholders purchase these shares in exchange for control, and firms gain capital to invest in their operations or expansion. Shareholders exercise this control by electing corporate governors, the “board of directors”, who oversee the operation of the firm. The corporate governors appoint chief managers or chief executives who run the firm’s daily operations. The executives report to the board of directors, who report to the shareholders. Board members are elected annually, either directly or via a proxy vote given by shareholders.
It is important to note that all common shares are not equal. Common shares can be assigned a “class”, which is defined by previous shareholders, the board of directors, and the firm itself. Different classes of shares can have different percentages of control for voting rights and earnings. The classes with more control are more valuable than those with less control.
Common shares have another benefit: liability separation. When a citizen owns a business directly, in a “sole proprietorship”, they can be held legally liable for any problems in the business. If the business loses a lawsuit for greater than the value of the firm, the owner may lose their personal assets. If they own a corporation through common shares, their potential losses are limited only to the share’s losses. The worst that can happen is all of their shares decrease to zero value. They cannot have claims levied on their personal property or assets. Shareholders are not liable for a firm’s failed obligations, with the exception of knowingly fraudulent activity.
In exchange for the ability to control the firm and a barrier from liability, shareholders are given “Residual Claim”. Residual claim means that common shareholders are the last to be reimbursed if a firm goes bankrupt. Since shareholders appoint the board of directors, the board of directors appoints the managers that set policy; shareholders are ultimately responsible for the company. Since shareholders cannot be legally liable beyond their investment, they are given last rights to any assets in bankruptcy.
Warrants are an option extended to existing shareholders of common equity by the firm. This option is only exercisable for a limited time by those who already own shares. Warrants are created by the issuing firm, and are extended to all current common equity shareholders in the exact proportion to their ownership of common shares. If all owners of common shares exercise their warrants, their ownership proportions will remain the same. If an owner does not exercise the warrant, their ownership share, voting power, and control may be reduced. This option from the firm comes at a set price. This price is called the exercise or strike price.
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