Bondholders vs. Shareholders: Understanding the Key Differences

Difference Between Bondholders and Shareholders

Bondholders and stockholders both represent individuals and institutions that have given money to a company in exchange for some sort of financial interest. Although both groups want the company to remain solvent, bondholders and stockholders earn profits differently and tend to have conflicting interests.

Bondholders

A bondholder is an individual or institution that owns a certain company's bonds. Bonds are essentially loans issued to the company from the bondholder. The bondholder issues cash to the business in exchange for a predetermined payback amount when the bond matures. Depending on the terms of the bond, the bondholder also may receive interest payments before the bond matures.

Bondholders have higher seniority than stockholders in the event that a company declares bankruptcy or liquidates. That means that the company has to pay back its obligations to bondholders before it compensates stockholders.

Stockholders

Stock represent units of ownership. Individuals and institutions that exchange cash for units of stock become partial owners of a company. Unlike bonds, stock doesn't have a maturity date and there's no guaranteed cash payout for buying stock. However, a company may issue periodic dividends to stockholders. If the company continues to perform well, stock prices will rise and stockholders get the opportunity to sell units of stock for a higher price than what they paid for it.

Bondholder-Stockholder Conflict

Neither bondholders nor stockholders want to see a company fail. However, the two groups tend to have different opinions about strategic risks and financial policies that the company enacts. The policies that create wealth for stockholder can endanger bondholders' investment and vice versa.

As long as the company remains solvent, bondholders get a fixed payout when the bond matures. That means that bondholders don't have any incentive to see the company take large risks that could endanger financial stability. Stockholders, on the other hand, make money when the value of the company rises. Because of this, stockholders often urge the company to take larger risks to reap a larger financial reward. Stockholders also benefit when the board of directors issues dividend payments, while bondholders do not. This conflict of interest can cause tension between the two groups.