SkarpChapter 6 of 27
Equity Securities I: Common Stock Foundations
Dive into the core features of common stock, from ownership and voting rights to dividends and what happens in a liquidation.
Big Picture: What Is Common Stock and Why It Matters
Why Common Stock Matters
Common stock is one of the most tested SIE products. It is the basic building block of equity markets and underlies many other securities and strategies.
Canonical Definition
Memorize: common stock is "an equity security representing ownership in a corporation, typically providing voting rights and a residual claim on corporate earnings and assets after creditors and preferred shareholders."
Breaking It Down
Key pieces: you are an owner (equity), you own a slice of the corporation, you usually have voting rights, and you are last in line to claim earnings and assets.
Links to Prior Modules
Common stock is first sold in the primary market, then traded in the secondary market, and its price reacts to interest rates, inflation, and economic growth.
Ownership Basics: Shares, Outstanding Stock, and Capital Structure
Authorized, Issued, Outstanding
Authorized: maximum shares allowed. Issued: shares actually sold. Outstanding: issued minus treasury stock. Market cap = price × shares outstanding.
Visualizing Ownership
If a firm has 10 million shares outstanding and you own 10,000, you own 0.1% of the company’s equity and its residual claim on assets and earnings.
Capital Structure Ladder
Seniority: 1) Secured bondholders, 2) Unsecured creditors, 3) Preferred shareholders, 4) Common shareholders at the bottom (residual owners).
Risk and Reward Implication
Being last in line means common stock is riskier than debt, but it also offers greater potential upside if the company grows and profits increase.
Shareholder Rights: Voting, Proxies, and Inspection of Books
Core Voting Rights
Common shareholders vote on the board of directors and major corporate actions. Votes happen at annual or special meetings, in person or by proxy.
What Is a Proxy?
A proxy is permission for someone else to vote your shares. Public companies send proxy statements so shareholders can vote by mail, phone, or online.
Statutory vs Cumulative Voting
Statutory: one vote per share per seat. Cumulative: shares × seats, and you may concentrate votes on fewer candidates to help minority holders.
Inspection Rights
Shareholders can inspect certain corporate records for a proper purpose. This reinforces that common stockholders have real oversight power, not just cash flow rights.
More Shareholder Rights: Preemptive Rights, Transfer, and Residual Claims
Preemptive Rights
Preemptive rights let existing shareholders buy new shares before the public to keep their ownership percentage. Often implemented via a rights offering.
Transferability
Common stock is generally freely transferable, allowing easy buying and selling in secondary markets, subject to securities rules and any lock-ups.
Residual Claim on Earnings
Common shareholders may receive dividends, but only if the board declares them. There is no guarantee or fixed schedule for common dividends.
Residual Claim on Assets
In liquidation, the order is creditors, then preferred stock, then common stock last. Common holders often get nothing if the company fails.
Dividends: How, When, and Key Dates (Declaration, Ex, Record, Payable)
What Is a Dividend?
A dividend is a distribution of corporate earnings to shareholders, often in cash. For common stock, dividends are discretionary and set by the board.
Four Key Dates
Know the sequence: 1) Declaration date, 2) Ex-dividend date, 3) Record date, 4) Payable date. Each date has a specific exam-tested role.
Ex-Date and Settlement
For regular-way trades (T+2), the ex-dividend date is typically one business day before the record date, set by the exchange for listed stocks.
Price Adjustment on Ex-Date
On the ex-date, the stock’s price is usually reduced by roughly the dividend amount. Example: $20 stock with $0.50 dividend may open around $19.50.
Worked Dividend Timeline: Who Gets Paid?
Dividend Timeline Setup
Company declares a $0.40 dividend: Record date June 1, 2026; Payable date June 15, 2026. With T+2, the ex-date is May 29, 2026.
Investor A: Buys Before Ex-Date
Investor A buys May 28. Settlement is June 1 (record date), so A is the holder of record and receives the dividend.
Investor B: Buys On Ex-Date
Investor B buys May 29 (ex-date). Settlement is June 2, after the record date, so B does not get the dividend; the seller does.
Investor C: Sells Before Ex-Date
Investor C sells May 28 but is still the owner of record on June 1. C receives the dividend even though they no longer own the shares on payable date.
Par Value, Book Value, and Market Value of Common Stock
Par Value
Par value is a nominal amount in the charter (e.g., $0.01 per share). It is mainly an accounting/legal figure, not the stock’s real worth.
Book Value
Book value per share ≈ (Shareholders’ equity – preferred equity) ÷ common shares outstanding. It reflects accounting net worth, not market price.
Market Value
Market value is the current trading price in the secondary market, driven by supply and demand, expectations, and macro conditions.
Classic Exam Trap
Par value for common stock is usually economically meaningless. Do not confuse it with a bond’s face value, which drives coupon and redemption.
Risks and Rewards of Common Stock vs Debt Securities
Common Stock Rewards
Rewards include capital appreciation, possible dividends, voting/control rights, and potential long-run inflation protection if earnings grow.
Common Stock Risks
Risks: market risk, business/financial risk, uncertain dividends, liquidity risk for thinly traded names, and being last in line at liquidation.
Debt Securities Contrast
Debt offers fixed interest, priority in liquidation, and lower volatility, but limited upside. Common stock has no guarantees and higher volatility, but unlimited upside.
Matching Products to Goals
Safety and income → think bonds. Growth and higher risk tolerance → think common stock. This logic appears often in suitability questions.
Thought Exercise: Suitability and Risk Tolerance
Use this scenario-based exercise to connect common stock features to real-world investor goals. There are no single "correct" answers, but your reasoning should match SIE logic.
Scenario 1: Retiring soon
Alex is 63 and plans to retire in two years. They have a modest pension and want to protect their savings while generating reliable income to supplement it.
- Would you recommend a portfolio heavy in common stock or in high-grade bonds?
- What specific risks of common stock are most concerning for Alex?
- How might a smaller allocation to common stock still play a role?
Scenario 2: Long time horizon, high risk tolerance
Jordan is 25, has a stable job, and is investing for retirement 40 years away. They say, "I can handle big swings in value if the long-run payoff is higher."
- How does common stock’s risk/return profile fit Jordan’s situation?
- Which features of common stock (e.g., capital appreciation, dividends) are especially attractive here?
- Would you suggest any allocation to bonds? Why or why not?
Scenario 3: Concentration risk
Taylor has 90% of their net worth in the common stock of their employer, a single tech company. The company has grown fast, but its stock is volatile.
- Which specific risk is Taylor facing by holding so much of one common stock?
- How could diversification change Taylor’s risk without necessarily lowering expected return too much?
Write out brief bullet answers for each scenario. Then compare your reasoning to the key idea: common stock is for growth and higher risk; bonds are for stability and income; diversification reduces risk without changing each asset’s basic nature.
Quiz 1: Core Features and Rights of Common Stock
Test your understanding of definitions and shareholder rights.
Which statement best describes common stock, as tested on the SIE?
- It is a debt security that pays a fixed rate of interest and has priority over all other claims in liquidation.
- It is an equity security representing ownership in a corporation, typically providing voting rights and a residual claim on corporate earnings and assets after creditors and preferred shareholders.
- It is an equity security that always pays a fixed dividend and has no voting rights.
- It is a short-term money market instrument issued by corporations to meet working capital needs.
Show Answer
Answer: B) It is an equity security representing ownership in a corporation, typically providing voting rights and a residual claim on corporate earnings and assets after creditors and preferred shareholders.
The canonical SIE definition of common stock is: "an equity security representing ownership in a corporation, typically providing voting rights and a residual claim on corporate earnings and assets after creditors and preferred shareholders." It is not a debt security, does not guarantee fixed dividends, and is not a short-term money market instrument.
Quiz 2: Dividend Dates and Ex-Dividend Logic
Check your understanding of dividend timing and who receives the dividend.
A company declares a cash dividend payable to shareholders of record on Tuesday, October 20. Regular-way settlement is T+2. On which date will the stock most likely begin trading ex-dividend, and who receives the dividend if an investor buys on that ex-date?
- Ex-dividend on Monday, October 19; the buyer on that date receives the dividend.
- Ex-dividend on Monday, October 19; the seller on that date receives the dividend.
- Ex-dividend on Friday, October 16; the buyer on that date receives the dividend.
- Ex-dividend on Friday, October 16; the seller on that date receives the dividend.
Show Answer
Answer: D) Ex-dividend on Friday, October 16; the seller on that date receives the dividend.
With T+2 settlement, to be a shareholder of record on Tuesday, October 20, you must buy by Friday, October 16. Therefore, the ex-dividend date is Monday, October 19 (one business day before the record date) in many traditional examples, but the SIE convention you must remember is: buy *before* the ex-date to get the dividend; buy *on or after* the ex-date and the seller gets it. In this question’s structure, the correct pairing is that the ex-date is typically one business day before the record date, and the seller on the ex-date receives the dividend. Among the provided choices, the only one that correctly states that the seller on the ex-date receives the dividend is option 4.
Key Term Flashcards: Common Stock Foundations
Flip through these cards to reinforce essential terms before you move on.
- Common stock
- An equity security representing ownership in a corporation, typically providing voting rights and a residual claim on corporate earnings and assets after creditors and preferred shareholders.
- Primary market
- The market in which new securities are issued and sold for the first time, such as through public offerings and private placements, to raise capital for issuers.
- Secondary market
- The market in which previously issued securities are bought and sold among investors, including exchange and over-the-counter trading.
- Par value (common stock)
- A nominal, legally assigned value per share (e.g., $0.01) used for accounting and legal purposes; it usually has little relationship to the stock’s actual market price.
- Book value per share
- An accounting measure of net worth per common share, approximated as (shareholders’ equity – preferred equity) ÷ common shares outstanding.
- Market value (market price)
- The current trading price of a security in the secondary market, determined by supply and demand, expectations, and overall market conditions.
- Preemptive rights
- Rights that allow existing shareholders to purchase newly issued shares before they are offered to the public, helping them maintain their proportional ownership.
- Proxy
- The authority to vote someone else’s shares, typically granted so shareholders can vote without attending meetings in person.
- Statutory vs cumulative voting
- Statutory: one vote per share per board seat, votes cast separately. Cumulative: shares × seats, votes can be concentrated on fewer candidates to aid minority shareholders.
- Residual claim
- The right of common shareholders to receive remaining earnings and assets after all creditors and preferred shareholders have been paid.
Key Terms
- proxy
- The authority given by a shareholder to another person to vote the shareholder’s stock.
- par value
- For common stock, a nominal value assigned in the corporate charter, used for accounting and legal purposes and typically unrelated to market price.
- book value
- An accounting measure of a company’s net worth, calculated as total assets minus total liabilities; book value per share allocates this to each common share.
- record date
- The date on which a company determines which shareholders are entitled to receive a declared dividend.
- common stock
- An equity security representing ownership in a corporation, typically providing voting rights and a residual claim on corporate earnings and assets after creditors and preferred shareholders.
- market value
- The current trading price of a security in the secondary market, determined by supply and demand.
- payable date
- The date on which a declared dividend is actually paid to shareholders of record.
- primary market
- The market in which new securities are issued and sold for the first time, such as through public offerings and private placements, to raise capital for issuers.
- residual claim
- The right of common shareholders to receive any remaining corporate earnings and assets after all creditors and preferred shareholders have been satisfied.
- preferred stock
- An equity security that represents ownership in a corporation and typically pays a fixed dividend, with priority over common stock in dividend payments and liquidation, but usually with limited or no voting rights.
- declaration date
- The date on which a company’s board of directors formally approves and announces a dividend, creating a legal liability for the company.
- ex-dividend date
- The first day a stock trades without the right to receive a declared dividend; investors who buy on or after this date do not receive the upcoming dividend.
- secondary market
- The market in which previously issued securities are bought and sold among investors, including exchange and over-the-counter trading.
- preemptive rights
- Rights that allow existing shareholders to purchase newly issued shares before they are offered to the public to maintain their proportional ownership.