How it works
Before floating on a stock exchange,
a company undergoes a valuation
process to set the initial price of its
shares. This process involves the
directors, prospective investors,
and an investment bank, which is
appointed to assess the company’s
value. Together, they reach a
decision on the most financially
viable price for the shares that will
be offered on the exchange. Upon
going public, a company issues
ordinary shares to investors as the
basic unit of ownership, commonly
referred to as a stake in the
business. A company may also
issue shares privately, rather
than publicly to investors
via the stock exchange,
to retain greater
management control.
Shares and dividends
When a company goes public, it sells shares to investors, who become
part-owners in return for capital investment. The number and type of
shares bought by each investor determines the size of their ownership.
A share of the pie
Ordinary shares, issued by all companies when they go
public, are the most common type of shares. There are also
other share types, which give the company more flexibility
to control rights available to different shareholder groups.
Most shares are sold on the stock exchange, but non-voting
and management shares are issued directly to holders.
Different types of shares entitle the holder to different rights.
Issued to employees, who:
Receive a part of remuneration
in the form of dividends
Have no voting rights
Receive no invitation to attend
annual general meeting (AGM)
Non-voting shares
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Issued (usually given not sold) to
owners and members of company
management, who have:
Extra voting rights, so control
of company stays in the same
hands
Management shares
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US_164-165_Shares_and_dividends.indd 164 09/11/2016 11:02
164 165
HOW FINANCE WORKS
Raising financing
698%
the increase in share
price of IPO VA Linux
Systems in one day on
the New York Stock
Exchange, in 1999
Flipping Buying and quickly reselling IPOs
for a large profit
Redeemable shares Shares that may be
later bought back by the issuing company for
a cash sum
NEED TO KNOW
RAISING MORE SHARE
CAPITAL
After the initial sale of shares, when a company
goes from private to public, the business can
raise additional funds by issuing more shares.
There are three main ways to do this:
Rights issue entitles existing shareholders
to buy additional shares from the company
within a set time frame, before they are
offered to other buyers.
Public issue is a process by which the
company issues a new allotment of shares
to sell to the public on the stock market.
Private placement is a practice by which the
company sells its shares (or other securities)
directly to private investors, usually large
institutions, bypassing the stock exchange
all together.
Shareholders:
Receive fixed dividend, paid
ahead of any dividends paid
out to ordinary shareholders
Take priority in receiving a share
of any assets left after debts are
paid if company is insolvent
Have fewer, if any, voting rights
Shareholders:
Share in the company dividends
Share in the company’s assets
Have right to attend AGM
Have right to vote on important
company matters such as
appointment of directors
Receive the company’s annual
report and financial statements
Shareholders receive company
dividends and share of assets, but
only after all other shareholders
Preferred stock
Common stock
Deferred stock
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US_164-165_Shares_and_dividends.indd 165 21/11/2014 16:39
164 165
HOW FINANCE WORKS
Raising financing
698%
the increase in share
price of IPO VA Linux
Systems in one day on
the New York Stock
Exchange, in 1999
Flipping Buying and quickly reselling IPOs
for a large profit
Redeemable shares Shares that may be
later bought back by the issuing company for
a cash sum
NEED TO KNOW
RAISING MORE SHARE
CAPITAL
After the initial sale of shares, when a company
goes from private to public, the business can
raise additional funds by issuing more shares.
There are three main ways to do this:
Rights issue entitles existing shareholders
to buy additional shares from the company
within a set time frame, before they are
offered to other buyers.
Public issue is a process by which the
company issues a new allotment of shares
to sell to the public on the stock market.
Private placement is a practice by which the
company sells its shares (or other securities)
directly to private investors, usually large
institutions, bypassing the stock exchange
all together.
Shareholders:
Receive fixed dividend, paid
ahead of any dividends paid
out to ordinary shareholders
Take priority in receiving a share
of any assets left after debts are
paid if company is insolvent
Have fewer, if any, voting rights
Shareholders:
Share in the company dividends
Share in the company’s assets
Have right to attend AGM
Have right to vote on important
company matters such as
appointment of directors
Receive the company’s annual
report and financial statements
Shareholders receive company
dividends and share of assets, but
only after all other shareholders
Preferred stock
Common stock
Deferred stock
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p
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h
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US_164-165_Shares_and_dividends.indd 165 21/11/2014 16:39
SHARES AND DIVIDENDS
Establishing share value
The forces of supply and demand
set the price of shares. Companies
issue only a limited number of
shares to the public, which can
then be bought and sold on the
stock exchange. Demand for those
shares is determined by whether
investors think the company has
good future economic prospects.
If investors believe that the
company is primed for substantial
growth, they will want to buy
shares in it, which consequently
drives up the share price.
25%
the drop in
share value over
four days during
the Wall Street
Crash of 1929
Rising value of
shares
Financial market observers believe
that the emphasis on optimizing the
value of shares for shareholders began
in 1976, when the idea of maximizing
profit for shareholders became a
priority. Since then, the market has
experienced a general upward trend
with occasional deep dips. The graph
tracks the average value of all shares
on London’s FTSE from 1964 to 2013.
A company occasionally carries
out a “share split” to its existing
shares. This increases the total
number of shares, although the
combined value of shares stays
the same. A share split allows a
company to lower the price of its
shares to bring them in line with
the price of competitor shares. The
share split is usually a two-for-one
or three-for-one increase, whereby
the shareholder sees the number
of their shares double or triple.
SPLITTING SHARES
VALUE
(INDEX
POINT)
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
Bear market Market that has
seen decline of 20 percent over a
period of 2 months or more
Bull market Market where share
prices are rising and investor
confidence is high
Market correction Short-term
decline in share prices to adjust
for an overvaluation
NEED TO KNOW
1972–1974
STOCK MARKET
CRASH
1987
OCTOBER 19: BLACK
MONDAY CRASH
1976
MAXIMIZING
SHAREHOLDER VALUE
THEORY PROPOSED
1980
1970
US_166-167_Shares_and_dividends.indd 166 21/11/2014 16:24
166 167
how finance works
Raising financing
1999
height of the
dot-com boom
2007
August: globAl
credit crunch
2000–2002
dot-com bust
2010
februAry: eurozone
debt crisis
1997
July: AsiAn
finAnciAl crisis
shAre price too high
A company listed on the stock
exchange has seen its share price
increase so that its shares now
cost more than its competitors’.
The high price puts off investors.
shAres split
The company decides on a share
split. It halves the price of each
existing $3 share, so each share
is now worth $1.50.
shAre certificAtes issued
It issues new share certificates to
holders, doubling shares held: a
shareholder with 1,000 shares at
$3 each now has 2,000 at $1.50
each. Total worth is still $3,000.
shAre vAlue Aligned
The value of shares is now
similar to that of competitors.
The price encourages new
investors to make a purchase.
3
$
$3
$1.50
$1.50
1,000
2,000
1990 2000 2010
yeAr
2001
9/11 terrorist
AttAck
in new york
US_166-167_Shares_and_dividends.indd 167 15/12/2014 12:58
166 167
how finance works
Raising financing
1999
height of the
dot-com boom
2007
August: globAl
credit crunch
2000–2002
dot-com bust
2010
februAry: eurozone
debt crisis
1997
July: AsiAn
finAnciAl crisis
shAre price too high
A company listed on the stock
exchange has seen its share price
increase so that its shares now
cost more than its competitors’.
The high price puts off investors.
shAres split
The company decides on a share
split. It halves the price of each
existing $3 share, so each share
is now worth $1.50.
shAre certificAtes issued
It issues new share certificates to
holders, doubling shares held: a
shareholder with 1,000 shares at
$3 each now has 2,000 at $1.50
each. Total worth is still $3,000.
shAre vAlue Aligned
The value of shares is now
similar to that of competitors.
The price encourages new
investors to make a purchase.
3
$
$3
$1.50
$1.50
1,000
2,000
1990 2000 2010
yeAr
2001
9/11 terrorist
AttAck
in new york
US_166-167_Shares_and_dividends.indd 167 15/12/2014 12:58
SHARES AND DIVIDENDS
What is a dividend?
Shareholders in a company are
usually entitled to a payment of
cash from its profits. The company
pays a dividend sum on every share
it has issued, but it is up to the
company’s board to decide how
much profit to reinvest and pay out.
Investors may look at a company’s
rate of dividend payout, along with
its capital growth, to gauge its
financial health and decide whether
to invest in it. Investors who rely
on shares for income are likely to
invest in companies that reliably
pay out dividends. In a good
economic climate, they win
twice—the dividend provides
income and the capital value of the
shareholding increases. However,
there is always a risk that the
value of shares will go down,
and companies only pay dividends
if they have made a profit.
Paying dividends is a good way
for a company to attract investors.
It is essentially a reward for putting
money into a company so that it
can fund its existing output and
develop and expand the business.
Announcing retained profits
At the end of the financial year, the company
announces its retained profits: the sum it intends
to keep for reinvesting or paying off debts rather
than pay out as dividends.
Making the decision for dividends
The board of directors makes a decision on
whether there is enough to warrant a dividend
payment, and if so, how much. It records details
of each payment in dividend vouchers.
Dividend yield ratio Measure
of how much a company pays out
in dividends relative to the price
of each share
Dividend per share Sum paid
on each share after retained
profits have been calculated
Dividend payout ratio
Percentage of a company’s net
income that is paid out in the
form of dividends
NEED TO KNOW
How it works
Shareholders usually receive a dividend if the company in which they hold
shares has retained enough profit in that financial year to make the payment.
The decision to make a payment is made by the board of directors. The dividend
might be paid every quarter (four times a year), or in two parts—an interim
dividend may be made partway through the year, with the final dividend paid
just after the end of the financial year.
$
$
$
$
$
$
US_168-169_shares_and_dividends.indd 168 21/11/2014 16:24
168 169
how finance works
Raising financing
1602
the year the Dutch East
India Company became
the first company to
issue stocks and bonds
When interest rates are low, shares with high dividend
payouts become extremely attractive to investors
because they provide a better return than investments
that yield an interest payment. This economic climate
encourages companies to pay out top-rate dividends
and so attract as many investors as possible, which in
turn increases the share value.
Conversely, when interest rates are rising, investors
may prefer to put their money into fixed-income
assets, which will pay high rates as a result of the hike
without the risk attached to buying shares.
INTEREST RATES AND DIVIDENDS
Making the payment
Most dividends are cash dividends. Sometimes
companies distribute stock dividends, issuing
more shares instead of cash to shareholders.
Paying taxes
Shareholders must
declare dividends on
their tax return and
pay taxes on them.
Keeping funds for growth
The company keeps some of its profit to put back into
the business. It needs to strike a balance between
pleasing investors and expanding its operation.
Investors are
attracted to
pay into
fixed-income
assets, such as
deposit accounts.
Investors are
attracted to
buy shares as
dividends give
a good return
for their money.
HIGH
INTEREST
RATES
LOW
INTEREST
RATES
$
$
$
$
$ $
$
US_168-169_shares_and_dividends.indd 169 21/11/2014 16:24
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