Saturday, October 3, 2009

Advantages and Disadvantages of Common Stock

Common stock has a number of disadvantage and disadvantages. Some of the factors to be reckoned with in considering common stock financing are discussed below.
Advantages. The basic advantages of common stock stem from the fact that it is a source of financing that places a minimum of constraints on the firm. Since dividends do not have to be paid on common stock and their nonpayment does not jeopardize the receipt of payment by other security holders, common stock financing is quite attractive. The fact that common stock has no maturity, thereby eliminating future repayment obligation, also enhances the desirability of common stock financing. Another advantage of common stock over other forms of long-term financing is its ability to increase the firm's borrowing power. The more common stock the firm sells, the larger the firm's equity base and therefore the more easily and cheaply long-term debt financing can be obtained.
Disadvantages. The disadvantages of common stock financing include the potential dilution of voting power and earnings. Only when rights are offered and exercised by their recipients can this be avoided. Of course, the dilution of voting power and earning resulting from new issues of common stock may go unnoticed by the small shareholder. Another disadvantage of common stock financing is it high cost. Normally, the most expensive form of long-term financing. This is because dividends are not tax-de-ductile and because common stock is a riskier security than either debt or preferred stock.

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