What is Common Stock, Anyway?
By S.P. Brown

It's more than a pretty piece of paper speculators traded for profit. Economically speaking, common stock is the residual claim ticket to a company's assets and earnings after preferred stockholders and debt holders have been perfected.

The operative word here is "claim." Common stockholders don't have direct ownership of the assets or earnings. In other words, a Wal-Mart shareholder can't just waltz into the local Wal-Mart and demand cash and merchandise for his stock certificate.

In reality, a shareholder would only gain ownership of a company's assets and earnings upon liquidation, but at that point, though, there probably wouldn't be much to own.

Beyond some nebulous claim on assets and earnings, common stock also bestows certain rights - the most important being a voice in the company's line of business, capital structure and board of director membership.

However, since the late 1940s, corporate lawyers and investment bankers have earned huge fees showing management how to silence this voice. This has been done through such tactics as the elimination of cumulative voting, the adoption of staggered boards and the requirement of super-majority voting.

In the good ole days, shareholders frequently had the right to cumulate their votes in favor of a single board candidate, so instead of one vote for each board member, they could aggregate all their votes for one particular nominee. This convention increased the chances of appointing a board member who was favorable to the shareholders' position. Unfortunately, the use of cumulative voting has been greatly reduced.

Staggered boards is another tactic used by management to usurp power. For example, it's not unusually for companies to put only one-third of the board up for election each year, which effectively reduces shareholder-voting power by two-thirds for any year. This makes it extremely difficult for investors to remove an incompetent board.

Furthermore, companies that employ the staggered board tacit will complement it with a super-majority requirement, which means a super-majority vote -- three-fourths in most instances -- is required to remove a disagreeable director.

But probably the most insidious display of power usurpation is the issuance of "special" equity securities. Many companies now issue different equity classes with different rights. For example, a company may issue class A and class B shares, where the former will get most of the implied shareholder rights, while the latter gets very little [see Ford (F) and Adolph Coors (RKY)].

The most egregious example of a special equity security destroying shareholder rights is the tracking stocks. For one, they can dilute shareholders' positions because they're usually issued as a secondary offering without preemptive rights. Additionally, they usually are issued on the company's fastest growing business segments. This means that current shareholders have their growth opportunities monetized, leaving them with the old, more mature business.

What's more, the tracking stock doesn't operate independently from current management. Rather, the same directors govern both the parent and tracking stock. This creates the possibility of a conflict, since what's good for the tracking stock may not be good for its parent.

Admittedly, for many traders, the notion of exerting some measure of control on management is meaningless. After all, these folks are doing nothing more than charting a company's stock movements to predict where the stock is headed. In fact, they may not even know what the company they trade in actually does.

That methodology is fine for traders. However, for investors looking to buy stocks for the long haul, management entrenchment and accountability to shareholders is a very important consideration.

No investor wants to be left holding just a pretty piece of paper.