A share of common stock represents the most basic form of ownership. As noted in Chapter 4, the owners of preferred stock usually do not have voting rights, but their claims on dividends and assets precede those of common stock owners. If the board of directors approves dividend payments, holders of preferred stock must receive their dividends before holders of common stock receive theirs. A corporation usually issues one type of common stock, but it may issue many types of preferred stock with varying dividends or dividend rates. When this occurs, management has two options.
Most large corporations distribute only a portion of their after-tax earnings to shareholders.
The portion of a corporation's profits that is not distributed to stockholders is called retained earnings . Because retained earnings are undistributed profits, they are considered a form of equity financing. More mature corporations may distribute 40 to 60 percent of their after-tax profits as dividends. Utility companies and other corporations with very stable earnings often pay out as much as 80 to 90 percent of what they earn. While corporations can sell stock to finance a business start-up and retain a portion of their profits to finance expansion, many entrepreneurs have fewer options.