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8.2.1 Benefits And Risks Of Common Share Ownership

Understanding the benefits and risks of common share ownership is crucial for investors seeking to maximize returns and minimize risks. This guide explores key aspects such as capital appreciation, voting privileges, and limited liability, alongside potential risks like market volatility and dividend uncertainty.

Benefits and Risks of Common Share Ownership

The right to buy or sell common shares in the open market at any time is an attractive feature; either process is a relatively simple matter with few legal formalities.

When a company first sells its shares to investors, the proceeds from the sale go to the company. However, when these outstanding shares are subsequently sold by their holders, the selling price is paid to the seller of the shares, not to the company. As a result, shares may be transferred from one owner to another without affecting the company’s operations or finances. From the company’s point of view, the effect of a sale is merely a new name appearing on its list of shareholders.

Benefits of Common Share Ownership

Common share ownership offers a variety of benefits, including, but not limited to:

  • Potential for Capital Appreciation: The primary goal for many investors is to benefit from the increase in the share price over time.
  • Common Share Dividends: Shareholders have the right to receive any dividends paid by the company.
  • Voting Privileges: These include the right to elect directors, approve financial statements and auditor’s reports, and vote on pertinent issues.
  • Favorable Tax Treatment: In Canada, both dividend income and capital gains may receive advantageous tax treatment.
  • Marketability: The shareholdings of most public companies can often be easily increased, decreased, or sold, ensuring liquidity.
  • Access to Information: Shareholders have the right to receive copies of the company’s annual and quarterly reports and other mandatory disclosures.
  • Examination of Company Documents: Shareholders are entitled to review certain company documents, such as by-laws and the register of shareholders, at specified times.
  • Questioning Management: The right to question management during shareholders’ meetings.
  • Limited Liability: Shareholders’ personal assets are protected; they can only lose what they invested in the shares.

Risks of Common Share Ownership

While common shares offer the potential for significant rewards, they also come with inherent risks:

  • No Obligation to Pay Dividends: The issuer is not legally obligated to pay dividends, relying solely on profits and intended company policies.
  • Limited Control: Common shareholders usually have minimal influence over day-to-day operations of the company.
  • Market Volatility: Common share prices can be highly volatile, with significant fluctuations leading to potential losses.
  • Subordinate Claims: In case of bankruptcy or dissolution, common shareholders have the lowest priority over assets, behind creditors, bondholders, and preferred shareholders.

Key Takeaways

  • Flexibility: The ability to buy and sell shares in the open market gives investors significant flexibility.
  • Capital Gains and Dividends: You can earn through capital gains if the stock price rises and through dividends if the company distributes profits.
  • Voting Rights: As a shareholder, you hold the right to vote on essential corporate matters.
  • Limited Liability: You are not personally liable for the company’s debts, beyond your investment in shares.
  • Volatility and Risks: Be aware that there is high risk due to market volatility and the lack of obligation on the issuer to pay dividends.

Glossary

  • Capital Appreciation: Increase in the value of an asset or investment over time.
  • Dividends: Earnings distributed to shareholders from company profits.
  • Voting Privileges: Rights granted to shareholders to vote on company matters.
  • Marketability: The ease with which an asset can be bought or sold in the market without affecting its price.
  • Limited Liability: A legal status where a shareholder’s financial responsibility is limited to the value of their investment.
  • Volatility: The degree of variation of a trading price series over time, indicating risk.
  • Subordinate Claims: In bankruptcy, these are claims that are ranked lower in priority compared to other claims.

FAQ

Q: What are some key benefits of owning common shares?

A: Some key benefits include the potential for capital appreciation, dividend income, voting rights, favorable tax treatments, and limited liability.

Q: What are the risks involved in common share ownership?

A: Risks include no obligation on the part of the issuer to pay dividends, market volatility, limited shareholder control, and subordinate claims in case of bankruptcy.

Q: Do common shareholders have any influence over company management?

A: Generally, common shareholders have minimal influence over daily operations but can vote on critical issues and elect the board of directors.

Q: How does common share ownership benefit from favorable tax treatment in Canada?

A: In Canada, both dividends received and capital gains from the sale of common shares are subject to favorable tax treatments, potentially reducing the overall tax liability for shareholders.


CSC® Exams Practice Questions

📚✨ CSC Exam Questions ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

## What is one of the attractive features of common share ownership? - [ ] Guaranteed dividends - [ ] High influence over company operations - [ ] Guaranteed capital gains - [x] The ability to buy or sell shares in the open market > **Explanation:** The right to buy or sell common shares in the open market at any time is an attractive feature because it allows shareholders flexibility and liquidity. ## When a company first sells its shares to investors, where do the proceeds go? - [ ] To the government - [x] To the company - [ ] To the shareholders - [ ] To the stock exchange > **Explanation:** The proceeds from the sale of shares during an initial issuance go to the company. However, when shares are subsequently traded, the proceeds go to the sellers. ## Which of the following is a benefit of owning common shares? - [ ] Guaranteed voting privileges regardless of share performance - [ ] Guaranteed dividends - [x] Potential for capital appreciation - [ ] Priority claim on company assets > **Explanation:** Common shares offer numerous benefits like the potential for capital appreciation, but they do not guarantee dividends or priority claims on company assets. ## What tax benefit is associated with common share ownership in Canada? - [ ] Tax-free income - [ ] Lower tax rate on interest income - [x] Favourable tax treatment of dividend income and capital gains - [ ] No tax on profits from sales > **Explanation:** In Canada, common share dividends and capital gains benefit from favourable tax treatment compared to other types of investment income. ## Who can vote on important company issues as a benefit of owning common shares? - [ ] Bondholders - [x] Common shareholders - [ ] Preferred shareholders - [ ] Creditors > **Explanation:** Common shareholders have voting privileges, including the right to elect directors, approve financial statements, and vote on important issues. ## What is a potential risk of investing in common shares regarding dividends? - [ ] Dividends are guaranteed to be low. - [ ] Dividends are always reinvested. - [x] The issuer has no obligation to pay dividends. - [ ] Dividends are paid only in the form of additional shares. > **Explanation:** Issuers of common shares are under no obligation to pay dividends, making dividend payments a discretionary benefit rather than a guaranteed one. ## In the case of bankruptcy or dissolution, which stakeholders have the lowest claim to company assets? - [ ] Creditors - [ ] Bondholders - [ ] Preferred shareholders - [x] Common shareholders > **Explanation:** Common shareholders fall behind creditors, bondholders, and preferred shareholders in terms of claims to assets in the event of bankruptcy or dissolution. ## What is limited liability in the context of common share ownership? - [ ] Shareholders can claim unlimited part of the company’s assets. - [x] Shareholders are only liable for their investment in the shares. - [ ] Shareholders have to cover the debts of the company. - [ ] Shareholders have unlimited voting rights. > **Explanation:** Limited liability means that common shareholders are only liable up to the amount of their investment in the shares and are not personally responsible for the company’s debts. ## Which of the following is NOT a benefit of common share ownership? - [ ] Marketability - [ ] Voting privileges - [ ] Right to receive annual and quarterly reports - [x] Priority in dividend payments > **Explanation:** While common shareholders enjoy numerous benefits, they do not receive dividend payments before preferred shareholders or other priority claims. ## Which of the following is a true statement about the volatility of common share prices? - [ ] Common share prices are fixed and stable. - [ ] Common share prices only go up. - [x] Common share prices can be volatile and lead to losing money. - [ ] Common share prices are less volatile than bond prices. > **Explanation:** Common share prices can be highly volatile, meaning their prices can fluctuate significantly, leading to potential gains or losses for investors.

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Sunday, July 21, 2024