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from Part II - Firm Valuation and Capital Structure
Published online by Cambridge University Press: 05 July 2013
INTRODUCTION
Stocks are ownership certificates in a company. In the theory of finance often “stocks” and “shares” are used synonymously. To understand this, consider the following example. One share of stock in a company with 2000 shares outstanding entitles the owner of the share to (1/2000) of the dividends paid by the company. If the company gets liquidated, then this ownership establishes a claim for (1/2000) of the net assets (assets minus liabilities) of the company. There are many reasons for issuing stock certificates by a company. For instance, for a new investment a firm may need some financial support to pay the bills until the cash inflows start coming. One way of raising money for the new investment is to issue stock certificates. Likewise, an entrepreneur can start a new company with the support of some financial backers. Once the company is established, the stockholders are entitled to the relevant shares of the profit that the company will generate in the future. Thus, there will be a stream of future payments. Another reason why a company may be interested in issuing shares in it is that this spreads the risk of the company among a large number of stockholders.
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