Equity Markets and Stock Instruments › What Is a Stock?

A stock, also called a share or equity, represents a unit of ownership in a corporation. When a company issues stock, it divides its ownership into shares and sells them to investors. The relationship between shares and ownership is proportional: if a company has 1 million shares outstanding and you own 10,000 shares, you hold 1% of the company. This fractional ownership structure allows companies to raise capital from thousands or even millions of investors while maintaining a clear accounting of who owns what portion of the enterprise.

Stock ownership confers rights that distinguish equity holders from creditors. Depending on the share class, these include voting on corporate matters, receiving declared dividends and sharing in remaining assets on liquidation. Company success can benefit shareholders through price appreciation and dividends, but neither is guaranteed. Common shareholders stand behind creditors and preferred shareholders in the capital structure and can recover nothing in bankruptcy. This greater exposure to business losses is one reason investors require an equity risk premium; it is not a guarantee that any stock will outperform a bond.

Companies also issue preferred stock, which combines equity ownership with preferential dividend or liquidation terms. Many issues pay a stated dividend, but payment terms vary and distributions are not universally guaranteed. Preferred holders generally rank ahead of common holders but behind creditors on liquidation, and typically have limited or no voting rights. We focus on common shares and their trading data in this chapter.

Companies raise capital through two primary channels: debt and equity. Each channel carries distinct advantages and obligations that shape corporate financial strategy. Issuing ordinary non-redeemable common stock provides capital without a contractual maturity date or scheduled principal repayment. This makes equity financing attractive for growth companies that need to invest heavily before generating consistent profits. A young technology company, for example, might burn through cash for years while developing products and building market share. Debt financing would be dangerous in this situation because interest and principal payments could force bankruptcy during lean years. Equity financing removes scheduled principal repayment on ordinary common shares, reducing that particular cash-flow pressure. It does not ensure that the company survives a downturn.

The initial public offering (IPO) marks a company's first sale of stock to the public and represents a major milestone in corporate life. Investment banks underwrite the offering, helping determine the initial price and finding buyers among institutional and retail investors. The IPO process involves extensive disclosure requirements and regulatory filings, and may include roadshows where company management pitches to potential investors. After the IPO, shares trade on secondary markets (exchanges) where investors buy and sell among themselves, and the company no longer receives proceeds from these transactions. This distinction between primary markets, where companies raise new capital, and secondary markets, where existing shares change hands, is fundamental to understanding equity market structure.

Beyond IPOs, companies can issue additional shares through follow-on offerings, raising more capital at the cost of diluting existing shareholders. When a company issues new shares, each existing share represents a smaller fraction of the total ownership. With the investor’s share count unchanged, a 1% stake becomes $1\%/1.05 \approx 0.9524\%$ if total shares outstanding rise by 5%. In a cash share buyback, the company pays cash to selling shareholders. All else equal, repurchasing shares reduces shares outstanding and increases the ownership fraction of holders who keep their shares. Concurrent share issuance can offset that reduction in shares outstanding. Their tax treatment depends on the jurisdiction and investor, and a repurchase is not by itself proof that shares are undervalued.