Synthesis: Equity Characteristics
This unit covered four key aspects of equity ownership. Use this framework when approaching equity characteristics questions on the exam.
Shareholder Rights Summary
| Right | Common Stock | Preferred Stock |
|---|
| Voting | Yes (statutory or cumulative) | Generally no (contingent if dividends in arrears) |
| Preemptive | Yes (maintain ownership %) | No |
| Liquidation | Last (residual claim) | Before common, after all debt |
- Cumulative voting favors minority shareholders by letting them concentrate all votes on fewer candidates
- Liquidation priority: secured creditors > unsecured creditors > subordinated debentures > preferred > common
- Both common and preferred stockholders have limited liability - can lose only the amount invested
Restricted Stock and Rule 144 Summary
| Key Rule | Reporting Company | Non-Reporting Company |
|---|
| Holding period | 6 months | 12 months (1 year) |
- Restricted stock: restricted because of what it is (unregistered)
- Control stock: restricted because of who holds it (affiliate)
- Affiliates always face restrictions (volume limits, Form 144, manner of sale) - even for open-market shares
- Non-affiliates who satisfy the holding period can sell freely with no volume limits or filings
- Form 144 required for affiliates if sales exceed 5,000 shares or $50,000 in a 3-month period
Dividend Mechanics Summary
| Dividend Type | Tax at Receipt | Effect on Value |
|---|
| Cash (qualified) | Long-term capital gains rates | Reduces company cash |
| Cash (ordinary) | Ordinary income rates | Reduces company cash |
| Stock dividend | Not taxed | No change (more shares, lower price) |
| Property dividend | Taxable at fair market value (FMV) | Reduces company assets |
- Dividends are not guaranteed; declared solely by the board of directors (shareholders do NOT vote on dividends)
- Must buy before ex-date to receive dividend
- Ex-date = record date under T+1 settlement (effective May 28, 2024)
- Cumulative preferred arrearages must be paid in full before common stockholders receive any dividend
Employee Stock Options Summary
| Feature | ISO (Incentive Stock Options) | NQSO (Nonqualified Stock Options) |
|---|
| Who receives | Employees only | Anyone (employees, contractors, directors) |
| Tax at exercise | No regular tax (alternative minimum tax (AMT) possible) | Ordinary income on the spread |
| Tax at sale | Long-term capital gains (if held) | Capital gains on post-exercise appreciation |
| Exercise price | Must be at least FMV at grant | Any price |
| Company deduction | None | Yes (equals employee's ordinary income) |
- ISO holding requirements: 2 years from grant AND 1 year from exercise
- ISO annual limit: $100,000 FMV vesting per year
- ISO exercise price must be at least FMV at grant; NQSO exercise price can be any price
- AMT (alternative minimum tax) may apply at ISO exercise even though no regular income tax is owed
Quick Decision Framework
When you see an equity characteristics question on the exam, identify which topic applies:
| If the question mentions... | Topic |
|---|
| Voting, proxy, cumulative, minority shareholder, preemptive rights | Shareholder rights |
| Rule 144, affiliate, holding period, unregistered shares, Form 144 | Restricted stock |
| Ex-date, record date, arrearages, cumulative preferred, qualified dividend | Dividends |
| ISO, NQSO, exercise price, AMT, vesting, disqualifying disposition | Employee stock options |