414.2
2.Common stock is called the "residual"
claim. Explain why it is called that and what the advantages and
disadvantages to having a residual claim are. (2)
Common stock is called the residual claim because its only claim is on what's "left-over" after the government (taxes) and bondholders have been paid. That is, if you think of the claimants on the firm's cash flows lining up to collect their portion, stockholders would be at the end of the line, but would get to keep all of what is left over.
The major disadvantage is that you are at the end of the line, so there is a chance that nothing will be there for you when it comes time to get your share.
The advantage is that all of the growth and profit above what you owe to bondholders is yours. Bondholders do not get paid more if the firm's products do really well. However, the stockholders (as residual claimants) get ALL of the residual, no matter how big it is.