Updated July 19, 2023
Definition of Stockholder
A stockholder is an individual, company, or other organization that holds an investment in the stock of a public or private company. This investment may take the form of preference shares, which entitle the holder to preference in dividends payment or assets, or equity shares, which provide the holder with voting rights and a share in the profits of the business. Equity stockholders are considered the owners of the company.
Explanation
A stockholder is a person who holds one or more shares of an organization’s stock. The holder may be an individual, entity, or company. Holding a stock represents ownership of the property to the extent of the holdings, but he or she is a separate entity from the organization. Being a separate legal entity, shareholders have limited liability to the extent of the capital contributed to pay off the company’s obligations. As the stockholder owns the business, they have an entitlement to the business’s profits, incentives, and success.
On the other hand, they bear the risk of adverse business conditions, such as when the company suffers a loss. This may lead to a fall in the stock’s market price, which in turn may cause the shareholder to lose their money or suffer a downfall in the value of their portfolio. Whatever the case may be, the shareholder is not personally responsible for the debts and responsibilities of the organization. Further, shareholders’ liability limits are only up to the amount of capital contributed.
Role of Stockholder
Stockholders are business owners who play an important role in the organization:
- Stockholders have voting rights and are responsible for the appointment and removal of directors.
- Deciding the amount of the director’s remuneration, i.e., salary or consultancy charges. This is a very brainstorming activity, as the stockholder must ensure that the amount paid compensates for the expenses and cost of directors.
- Certain decisions require prior approval of shareholders, for example:
- Changing the company’s constitution
- Declaring dividend
- Approving financial statements of the company
- Wind up under voluntary liquidation
Types of Stockholders
There are two types of stockholders:
1. Common Stockholders
Common stockholders are the owners of the company and have voting rights, which allows them to participate in meetings and control the company’s operations. In addition, they are reimbursed with the payment of dividends after making payments to preferred stockholders. Common stockholders are the important investors of the company and are a major source of funds. These shares are also known as ordinary or equity shares or residual owners of the company.
2. Preferred Stockholders
Preference stockholders have preference over dividend payments and claim settlement over common stockholders. They may receive a fixed dividend and get the payment before the common stockholders. In case of liquidation, the preferred stockholder’s claim will reach a settlement prior to the common stock from the assets realized. However, these shares do not have any voting rights and therefore are not considered company owners.
Duties and Responsibilities of a Stockholder
Stockholders do not directly participate in the day-to-day business of the company. Instead, they appoint a board of directors who manage the company’s business and make major decisions related to finance, capital budgeting, and business expansion. Thus, the election of the board of directors is a crucial responsibility of stockholders, as they are responsible for deciding the future course of the company’s operation.
Stockholders also act as a source of funds for the company, and timely payment of the called-up amount becomes an important duty. Deciding on the dividend declaration is another significant responsibility of stockholders. They determine the future course of action for earned profits, i.e., whether to declare and distribute profits as dividends or reinvest them in business expansion. In the event of liquidation of the company, stockholders are considered responsible for payment of company liabilities, but this liability is limited to the amount of capital contributed by them. As a separate legal entity, stockholders do not have any personal liability.
(Please note that most of the points discussed above relate to equity stockholders. Preference stockholders do not have such roles and responsibilities.)
Stockholder Equity
Stockholder equity, also known as shareholder equity or shareholders’ fund, refers to the sum total of the share capital, retained earnings, other reserves, and surplus. It is the sum total of all assets available reduced by external liabilities. Furthermore, stockholders’ equity includes common stock, retained earnings, paid-in capital, and treasury stock. It is a crucial financial term for analyzing the funds retained within the business. If the stockholder equity is negative, it signifies that the company is incurring losses and not operating profitably.
The formula for calculating stockholder equity is as follows:
Several components affect stockholder equity:
1. Share Capital
Share capital refers to the initial amount invested by the company’s shareholders. The share capital may change over time with public offerings. It is reported in the balance sheet under the shareholders’ Equity section. Further, the maximum amount that can be raised through share capital is the amount of authorized share capital. This is the initial amount of capital investment by the shareholders of the entity in the form of cash, property, or any other form and is a security that represents the ownership of a company.
Common stockholders vote for corporate policies and elect the board of directors. Equity ownership yields higher returns in the long term. These holders of common stock have rights to assets at the time of liquidation once the preference shareholders, bondholders, and other debts are clear. Common stock has a higher risk than preference shares and bonds, as they are the ultimate owners of the business.
2. Retained Earnings
Retained earnings refer to the balance of net profits that are retained in the business after distributing dividends to its shareholders. Furthermore, the company’s board of directors determines the amount of profits to be retained in the business or distributed to shareholders with the shareholders’ consent.
3. Other Reserves and Surplus
All other reserves and surpluses that accrue, such as security premium reserve (amount called up over and above equity share par value), capital reserve, and other statutory reserves, also form a part of shareholders’ equity.
Conclusion
A stockholder is an individual who owns shares in a company, signifying ownership rights in the business. These shares may be equity shares, providing voting and ownership rights, or preference shares, offering priority in certain distributions over equity shares. Stockholders are a significant source of funds for companies, particularly those that wish to avoid high debt positions, as they may fund business requirements through share capital issuance. Stockholders have certain rights and play an indirect but vital role in company operations.
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