Common Stock Basics
Common stock represents ownership in a corporation and forms the foundation of equity securities. As a Series 7 representative, understanding common stock is essential because it's one of the most widely traded securities you'll encounter.
What is Common Stock?
Common stock is a security that represents proportional ownership in a corporation. When investors purchase common stock, they become part-owners (shareholders) of the company and have a claim on a portion of the company's assets and earnings.
Unlike bondholders who are creditors, common stockholders are equity owners. This distinction matters significantly during liquidation—bondholders and other creditors must be paid before common stockholders receive anything.
Shareholder Rights
Common stockholders enjoy several fundamental rights:
| Right | Description |
|---|---|
| Voting Rights | Vote on major corporate matters including board elections |
| Dividend Rights | Receive dividends when declared by the board |
| Preemptive Rights | Maintain proportional ownership when new shares are issued |
| Inspection Rights | Review corporate books and records |
| Residual Claim | Receive remaining assets after all creditors in liquidation |
Voting Rights
Common stockholders typically receive one vote per share on corporate matters. There are two primary voting methods:
Statutory (Regular) Voting — Each share gets one vote per position being elected. If you own 100 shares and three directors are being elected, you cast 100 votes for each of the three positions separately.
Cumulative Voting — Shareholders can aggregate all their votes and cast them for one or more candidates. With 100 shares and three director positions, you'd have 300 total votes (100 × 3) that you could concentrate on a single candidate. This method benefits minority shareholders.
Proxy voting allows shareholders who cannot attend meetings to authorize another party to vote on their behalf. Public companies must solicit proxies for annual meetings.
Share Terminology
Understanding share classifications is crucial:
| Term | Definition |
|---|---|
| Authorized Shares | Maximum shares the company can issue per its charter |
| Issued Shares | Shares that have been sold to investors |
| Outstanding Shares | Issued shares currently held by shareholders |
| Treasury Stock | Issued shares repurchased by the company |
Key Formula: Outstanding Shares = Issued Shares − Treasury Stock
Treasury stock has no voting rights and receives no dividends. Companies may repurchase shares to increase earnings per share, fund employee compensation plans, or prevent hostile takeovers.
Par Value vs. Market Value
Par value is an arbitrary dollar amount assigned to stock in the corporate charter, typically set very low (e.g., $0.01 or $1). Par value has minimal relevance for common stock and doesn't represent actual worth.
Market value is the current trading price determined by supply and demand. This is what investors pay when buying shares on the open market. Market value can fluctuate significantly based on company performance, economic conditions, and investor sentiment.
Limited Liability
One key advantage of common stock ownership is limited liability. Shareholders can lose only the amount they invested—their personal assets are protected from corporate debts. This differs from general partnerships where partners have unlimited personal liability.
On the Exam
The Series 7 exam frequently tests:
- The order of claims in liquidation (common stockholders are last)
- Differences between statutory and cumulative voting
- Calculation questions involving outstanding shares
- Understanding that common stockholders have no guaranteed dividends
In a corporate liquidation, common stockholders are paid:
An investor owns 200 shares of XYZ Corporation. At the annual meeting, four directors are being elected using cumulative voting. How many total votes does this investor have?
A corporation has 10 million authorized shares, 8 million issued shares, and 1 million shares held as treasury stock. How many shares are outstanding?
1.2 Dividends and Stock Splits
Continue learning