Chapter 7: Corporate Valuation and Stock Valuation
Stock prices are volatile, so it is difficult to estimate a stock’s value.
This chapter addresses those questions through the application of two widely
used valuation models: the free cash flow valuation model and the dividend
growth model.
Common stockholders are the owners of a corporation, and as such they have
certain rights and privileges as discussed in this section.
A firm’s common stockholders have the right to elect its directors, who, in turn,
select the senior executives who manage the business. In a small firm, the largest
stockholder typically serves as president and chairperson of the board. In a large,
publicly owned firm, the managers typically have some stock, but their personal
holdings are generally insufficient to give them voting control.
Corporations must hold periodic elections to select directors, usually once a year,
with the vote taken at the annual meeting. At some companies, all directors are
elected each year for a 1-year term.
Each share of stock has one vote, so the owner of 1,000 shares has 1,000 votes for
each director.
, Stockholders can appear at the annual meeting and vote in person, but typically
they transfer their right to vote to another party by means of a proxy.
proxy
A document giving one person the authority to act for another, typically the power to vote shares
of common stock.
proxy fight
An attempt to take over a company in which an outside group solicits existing
shareholders’ proxies, which are authorizations to vote shares in a shareholders’
meeting, in an effort to overthrow management and take control of the business.
preemptive right
Gives the current shareholders the right to purchase any new shares issued in proportion to their
current holdings. The preemptive right enables current owners to maintain their proportionate
share of ownership and control of the business.
The preemptive right allows current common stockholders to purchase any
additional shares sold by the firm.
The preemptive right enables current stockholders to maintain control, and it
also prevents a transfer of wealth from current stockholders to new stockholders.
If not for this safeguard, the management of a corporation could issue additional
shares at a low price and purchase these shares itself. Management could thereby
seize control of the corporation and steal value from the current stockholders.
selling common stock at a price below the market value would dilute its price and
transfer wealth from the present stockholders to those who were allowed to
purchase the new shares. The preemptive right prevents such occurrences.
classified stock
Sometimes created by a firm to meet special needs and circumstances. Generally,
when special classifications of stock are used, one type is designated “Class A,”
another as “Class B,” and so on. For example, Class A might be entitled to receive
dividends before dividends can be paid on Class B stock. Class B might have the
exclusive right to vote. Also known as dual class stock if there are two classes.
dual class shares
Classified stock with two classes having different dividend rights or voting rights.
