A pro rata allocation of common stock occurs when common shares are sold to investors. An investor who purchases shares of common stock receives a unit of ownership of the company for each share purchased. The amount of common shares owned determines how much dividends are allocated to him, how much stock he receives in a stock split and how much assets are distributed to him in the event of a corporate liquidation.
Outstanding Common Stock
Common stock is said to be outstanding when it is in the hands of stockholders. When an investor purchases common shares she is acquiring a percentage of ownership in the company; the amount owned is based on the number of shares she owns of the total common stock outstanding. For example, if Lily buys 10,000 shares of 500,000 shares of common stock outstanding, she has a 2 percent ownership interest in the company (10,000 shares divided by 500,000 shares).
Distribution of Dividends
When dividends are declared by a company’s board of directors, the dividend to be paid to shareholders is disclosed as a per share amount. For example, World Corporation’s board declares a dividend of $1.50 per share. Lily, who owns 10,000 common shares, receives a dividend of $15,000, or $1.50 multiplied by 10,000 shares.
Stock splits occur when a company issues additional shares to investors at no cost. The stock split reduces the par value or stated value of common stock. Assume World Corporation issues a 2-for-1 stock split; for every share owned by an investor, an additional share is issued to her. After the stock split, Lily’s original 10,000 shares now turn into an ownership of 20,000 shares.
Distribution of Assets
In the event of a corporate liquidation, assets are used to pay off liabilities and owners’ interests. Common stockholders are not guaranteed a return of their investment since they have the last claim on assets. For those owners who do receive their investment, the cash received is limited to the number of shares owned. Assume World Corporation decides to shut down operations and the current market price of their common shares is $15. Lily receives $30,000 for her investment, or 20,000 shares multiplied by the $15 market price of the stock.