TYPES OF COMMON STOCK
Although most firms have only one type of common stock, in some instances
classified stock is used to meet special needs. Generally, when special classifica-
tions are used, one type is designated Class A, another Class B, and so on. Small,
new companies seeking funds from outside sources frequently use different
types of common stock. For example, when Genetic Concepts went public
recently, its Class A stock was sold to the public and paid a dividend, but this
stock had no voting rights for five years. Its Class B stock, which was retained
by the organizers of the company, had full voting rights for five years, but the
legal terms stated that dividends could not be paid on the Class B stock until the
company had established its earning power by building up retained earnings to
a designated level. The use of classified stock thus enabled the public to take a
position in a conservatively financed growth company without sacrificing
income, while the founders retained absolute control during the crucial early
stages of the firm’s development. At the same time, outside investors were pro-
tected against excessive withdrawals of funds by the original owners.
As is often
the case in such situations, the Class B stock was also called founders’ shares.
Note that “Class A,” “Class B,” and so on, have no standard meanings. Most
firms have no classified shares, but a firm that does could designate its Class B
shares as founders’ shares and its Class A shares as those sold to the public,
while another could reverse these designations. Still other firms could use stock
classifications for entirely different purposes. For example, when General Motors
acquired Hughes Aircraft for $5 billion, it paid in part with a new Class H com-
mon, GMH, which had limited voting rights and whose dividends were tied to
Hughes’s performance as a GM subsidiary.
The reasons for the new stock were
that (1) GM wanted to limit voting privileges on the new classified stock because
of management’s concern about a possible takeover and (2) Hughes employees
wanted to be rewarded more directly on Hughes’s own performance than would
have been possible through regular GM stock. These Class H shares disappeared
in 2003 when GM decided to sell off the Hughes unit.
What are some reasons why a company might use classified stock?