Chapter 9

9

Capital Stocks

C H A P T E R

Chapter Objectives

• Compare the different classes of stock available.• Describe the rights of a stockholder.• Understand how a company decides whether to go

public.• Describe how a smaller sport business can issue stock.• Understand how stocks are issued.• Understand the evolution of sport stocks.• Compare the various publicly traded sport businesses.

Common Stock

• Most frequently issued and utilized • Represent an equity ownership right in a company• Low on the repayment list after secured creditors

are repaid and holders of preferred shares are paid• Example:

– Phil Knight, cofounder of Nike, owns 95.5% of the class. A shares and 95,652,015 class B shares, which together make up approximately 36.1% of the 268 million outstanding shares of Nike.

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Common Stock (continued)

• Mutual Fund– Purchase numerous shares of various stocks using

money from various investors including institutions and individuals

– Specialized mutual funds that can invest in sport stocks, social equity stocks, global stocks, or aggressive growth stocks

– Might have millions of shares in hundreds of stocks; professional administrators of each fund analyze each stock and try to pick the best time to buy or sell the fund’s shares

Preferred Stock• Carries a dividend preference in relation to common

stock– Dividend is cumulative in that if it is not paid to holders of preferred

stock in a given year, the next year the corporation will owe two years’ worth of dividends.

• Other benefits that are available for preferred stockholders include the following:– The right to dividend payments before common stock shareholders receive

dividend payments

– Preference as to assets in distribution

– Voting power for preferred stock, available under limited circumstances

– Strong redemption provisions

– Subscription privileges to future stock offerings

– The right to convert preferred stock to common stock

Shareholder Rights

• To transfer the stock freely, within limited rules• To exercise the right to vote in person or by proxy

as set forth in the corporation’s bylaws• To receive dividends and other disbursements on

a pro rata basis according to the number of shares held

• To receive disbursements on a pro rata basis when a partial or complete liquidation of corporate assets occurs

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Shareholder Rights (continued)

• To bring action on behalf of the corporation against board members who do not act in the corporation’s best interest (commonly referred to as stockholders’ derivative actions)

• To obtain information from the corporation to help safeguard the stockholders’ investment (such as an annual report)

• To subscribe pro rata to new shares of company stocks when authorized by law (commonly referred to as stockholders’ preemptive right)

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Shareholders Rights (continued)

• Preemptive Right

– This protects a stockholder’s power of control and prevents dilution of the stock’s value.

– The right to exercise control over a business is one of the primary purposes.

• If you own 10% of the business, you are entitled to purchase 10% of the newly issued shares.

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Shareholders’ Rights (continued)

• Voting Power

– Stockholders have the right to elect board members.

– Each shareholder is entitled to one vote for each share held.

• Holding Companies

– Parties can obtain control by investing in a company.

• For example, a company that has one million outstanding shares can be effectively controlled by anyone who purchases 50.01% of the voting stock.

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Shareholders’ Rights (continued)

• Defensive Tactics

– Hostile takeover: Unwelcome attempt to purchase the shares of a company.

– Golden parachute contracts: Require huge payments to executives if they are terminated; can make a company less attractive to any potential takeover attempts.

– Warrants: Management can buy shares at the fixed warrant price, which will allow them to purchase more shares; can discourage hostile takeover attempts.

Going Public

• Must determine whether the stock will be publicly traded– Just because a company has issued stock and has

gone public does not mean the shares will be available to the general public.• Small corporations may have only a few shareholders, such as

family members.

• Must decide whether to list the shares on a major exchange or to have unlisted shares traded on the over-the-counter (OTC) market

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Going Public (continued)

• Shares will go through three possible phases once the decision to go public is made:– Phase 1: initial public offering (IPO)

The purpose of the IPO is to raise new capital for the business and to put money into the owner’s hands.

– Phase 2: secondary marketStocks are bought and sold for all publicly traded businesses after the IPO.

– Phase 3: primary marketExists for companies that have already had an IPO but want to issue more shares to generate additional funds.

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Going Public (continued)

• Shares can be sold to five possible types of buyers:1. Existing shareholders on a pro rata basis

2. Investment bankers, who will then sell the shares to the general public in an IPO

3. Several major purchasers in a private placement

4. Employees in an employee stock purchase plan

5. Buyers in a dividend reinvestment plan(continued)

Going Public (continued)

• Advantages

– Owners are allowed to diversify their investments instead of having all their assets locked into the company.

– A liquid asset is created (a privately held company would be harder to sell).

– Going public helps raise new cash for growth.

– A value for the company is established based on the combined value of outstanding shares.

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Going Public (continued)• Disadvantages

– Increased operating costs are associated with all the quarterly and yearly reporting requirements.

– The company is required to disclose sensitive data that a competitor can use against the business.

– Self-dealing and nepotism are not allowed.

– There is a risk that the value of shares will drop if the market for the shares is slow and they are not traded enough or if the company or its sector falls into disfavor.

– Loss of control of the business is possible if investors acquire enough stock.

Financing a Company Through Stock• Advantages

– There is no fixed cost associated with issuing stock, whereas a company that issues bonds or commercial paper will have to allocate a fixed amount in the budget for debt service.

– Common stocks do not carry any fixed maturity date at which they need to be paid.

– Issuing common stock can help raise new capital without affecting the company’s bond rating.

– At times, such as when interest rates are low and the demand for bonds is also low, it is easier to sell common stock.

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Financing a Company ThroughStock (continued)

• Disadvantages

– Issuing bonds or commercial paper provides a predictable fixed cost for repayment in contrast to stocks, which represent a stake in the company’s future profits.

– The costs associated with issuing stocks and all ancillary activities can make issuing common stock more expensive than issuing preferred stock or debt instruments.

– Some investors may see issuing new stock as a negative sign that the company needs to sell more of itself in order to survive.

Selling Shares

• Subscription: Selling to prior shareholders.

• Initial public offering (IPO):

– Includes private placement

– SEC regulations

Increasing Stock Value• A business increases in value through a rise in the value of

its shares.

• External factors that can affect the value of professional sports teams include the following:– Antitrust decisions affecting the league– Labor disputes and unwillingness of players to cross the picket

lines to play– Environmental regulations affecting the arena– A change in workplace safety rules that apply to operating the

team– New rules related to employment practices in the workplace,

such as the classification of food vendors as employees rather than independent contractors

– The folding of a rival league or the success of another league(continued)

Increasing Stock Value (continued)• Internal factors that can affect the value of

professional sports teams include the following:– Trading a star player or hiring a new coach– Increasing the number of preseason games– Borrowing money for expansion or issuing more stocks– Declaring a dividend– Consolidating television and radio broadcasting

operations in-house

Publicly Traded Sport Companies

• The Cleveland Cavaliers went public in 1970 for $5 per share, but shares dropped to as low as $0.50 per share in 1982. The team went private in 1984 for $1.25 per share.

• The New England Patriots went public in 1960 for $5 per share and went private in 1976 for $15 per share.

• The Baltimore Orioles went on a roller-coaster ride in the 1970s, with their stock price ranging from $8 to $25.50. In 1979 the team went private, with liquidation value earning shareholders $49.60 per share over a three-year period.

• The Milwaukee Bucks went public in 1968 for $5 per share and went private for $12 per share 11 years later.

Sport Stocks• Green Bay Packers, one of the most well known (American)

public sports teams:– Very limited number of shares; sale of shares happens only on

occasion

– Not traded publicly on the market

• Pure play: corporation that participates in only one industry segment– For example, Boston Celtics or Cleveland Indians (when they were

public)

• Blended company: encompasses a team and other unrelated businesses – For example, Disney (ESPN), Comcast (Philadelphia Flyers and

76ers)

Questions for Class Discussion

1. How many people in your class own stocks?

2. Have you ever purchased stocks yourself or been given stocks? If you purchased them yourself, what factors went into buying those shares?

3. Have you ever thought about buying stocks? Have you ever researched them?

4. Would you ever buy any sport stocks? Why or why not?

5. What sport stocks would you consider purchasing? Why?

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Questions for Class Discussion (continued)

6. Would you invest in a mutual fund? Why or why not?

7. Have you ever lost money on an investment? Explain what happened and what you learned from the process.

8. Do you think that buying the publicly available shares in the Green Bay Packers is a good investment?

9. What key facts about a stock might make you think that it would be a good investment?