Question

What is meant by the statement “common stockholders have a residual claim on the issuing firm’s assets”?

Answer 1

The statement common stockholders have a residual claim on issuing firm's assets means :

-In the event of liquidation, common stockholders have the lowest priority in terms of any cash distribution.

-dividends are paid out of net income

-common stockholders have the lowest priority on the corporation's assets in the event of bankruptcy.

COMMON STOCK IS RISKIER THAN BONDS OF THE SAME FIRM

In Detail

Owning common stock is an effective way to benefit from the increases in equity in a company. Common stockholders have a few rights that come with owning stock in the company. One of the features of owning common stock is the residual right for company shareholders.

Right to Earnings

One of the aspects of the residual right of common stockholders is the right to earnings. This means that when you own a share of common stock, you are entitled to a certain percentage of the earnings of the company. You are entitled to a share of the earnings of the company for as long as the company is in business or as long as you own the share of stock. This is provided in the form of regular dividends.

Claim on Assets

Besides the right to a percentage of earnings, you are also entitled to the assets of the company. Since you own a percentage of the company, you also own a percentage of every asset that the company has. This means that if the company goes out of business, you will have a legal claim on any of these assets. During the bankruptcy process, the company will have its property liquidated to repay creditors and shareholders.

Collecting Assets

Although you have a legal right to make a claim on part of the assets of the company, it does not necessarily mean that you will be able to. The common stockholder has the lowest priority when it comes to claiming the assets of the company. The lenders with secured loans have the first claim on assets. Unsecured creditors come next, followed by bondholders. At that point, preferred stockholders have the next claim and finally, common stockholders get what is left. In most cases, this does not leave anything to collect.

Dividends

When you are a stockholder, you are entitled to a certain amount of dividends. However, the size of your dividend can fluctuate. Common stockholders are not guaranteed to receive a specific dividend. Preferred stockholders are required to have a certain amount of dividend paid to them on a regular schedule. If the company decides not to issue a normal dividend because it needs to use the earnings for something else, it has the right to postpone the dividend.