General Securities Representative Exam/Equity Securities
A corporation can create capital by offering shares of the corporation to the public. These shares are Equity Securities, or stocks. When a corporation wants to sell equity securities it first applies for a charter that states the par-value and the number of authorized shares. Here is an outline of the types of shares:
Stocks may either be common stock or preferred stock. Holders of Common Stock enjoy the following rights as part owner of the corporation:
- The right to a certificate
- A share of profits in the form of dividends, when and if paid
- The right to attend shareholder meetings and to vote on matters, particularly election of the board of directors
- The right to transfer or sell their shares of the stock
- Access to information about the corporation like financial statements
- Pre-emptive offer of newly issued stocks proportionate to their current holdings.
Dividends may either be in the form of cash paid to the share holder, additional shares, or some combination of both. If the dividend is paid in shares, each shareholder's percent ownership remains the same since all shareholders receive equal dividend shares for each share owned. Dividends paid in shares increase the number of outstanding shares, but not the par-value. Dividends are paid to common stock holders after all debts are paid, and after dividends are paid to shareholders of preferred stock.
Owners of Preferred Stock have a priority claim to any remaining assets in bankruptcy after creditors (for example, bondholders) have been paid, but before any payments are available to common stockholders. Preferred shares also may have a guaranteed dividend, and sometimes offer superior voting powers to common shareholders. It is important to individually review the rights attached to a corporation's preferred shares as additional rights vary significantly from company to company. Some preferred shares have no voting rights at all, or may not offer guarantee dividends.
Dividends paid to preferred stockholders are usually at a fixed rate based on the par-value, and can be cumulative, meaning that if a dividend was not paid for some reason that dividend will accumulate and must be paid in arrears when the funds become available. Preferred stock can also be convertible to a fixed amount of common stocks. It can also be callable, meaning the corporation can call or buy back preferred shares. Also preferred stocks can participate in dividends paid to common shareholders.
A corporation can propose to the share holders to split the stock in order to make the stock more affordable to investors. Shareholders have the option to vote for or against the split. If the split proposal passes, then the number of outstanding shares increases proportionate to the ratio of the split. Say for a 2:1 split, then each shareholder would get an additional share, thus doubling the number of outstanding shares. The new shares come from the original authorized shares that were unissued. Splitting a stock, say 1:2, would reduce the share price to half the pre-split value, and it also would split the par-value of the shares. A stock can also have a reverse split. This would make the stock more attractive to investors if the share value was low. Reverse splits reduces the number of outstanding shares and the par-value proportionate to the split ratio, say 1:2 for example.