Common Stock

Common stock is the most fundamental equity security: it represents direct ownership in a corporation.

Ownership and Rights

• Common stock represents an equity (ownership) stake in a corporation
• Each share typically carries one vote per share on corporate matters
• Shareholders vote on:
  • Board of directors elections
  • Mergers and acquisitions
  • Amendments to the corporate charter
• Ownership percentage is determined by shares held relative to total shares outstanding

Dividend Rights

• Common stockholders are entitled to share in corporate profits through dividends
• Dividends are not guaranteed - the board of directors decides whether to declare them
• Common dividends are variable - they can increase, decrease, or be eliminated entirely
• Common dividends are paid after preferred dividends have been satisfied
• Dividends can be paid in cash, additional shares (stock dividends), or property

Exam Tip: Gotchas

Common stock dividends are never guaranteed. Even a company with record profits can choose not to pay dividends. The board has full discretion, and common dividends are always paid after preferred dividends.

Liquidation Priority

If a corporation is liquidated, assets are distributed in a strict order. Common stockholders are last in line:

Think of it this way: Imagine a line at a buffet. Secured creditors eat first, then unsecured creditors, then preferred shareholders. Common shareholders are at the back of the line, and if the food runs out before their turn, they get nothing.

• Common shareholders only receive assets after all creditors and preferred shareholders have been paid in full
• In practice, common shareholders often receive little or nothing in a liquidation

Exam Tip: Gotchas

Common stockholders have the highest risk in a corporate liquidation. They are paid last, after secured creditors, unsecured creditors, and preferred stockholders. If the exam asks who bears the most risk in bankruptcy, the answer is common shareholders.

Risk and Return Profile

• Unlimited upside potential - no cap on how high the stock price can rise
• Limited downside - maximum loss is the total amount invested (shares cannot go below zero)
• Higher risk than preferred stock or bonds, but historically higher long-term returns

Domestic vs. Foreign Common Stock

Domestic stock refers to shares of companies incorporated in the United States. Foreign stock refers to shares of companies incorporated outside the U.S.

American Depositary Receipts (ADRs)

Rather than buying shares directly on a foreign exchange, U.S. investors can access foreign companies through ADRs:

• Negotiable certificates issued by U.S. depositary banks representing shares of foreign companies
• Trade on U.S. exchanges (NYSE, NASDAQ) in U.S. dollars
• Dividends are converted from the foreign currency to U.S. dollars by the depositary bank
• Each ADR may represent a fraction of one share, exactly one share, or multiple shares of the foreign company

Additional Risks of Foreign Stock

Investing in foreign securities (whether directly or through ADRs) carries risks beyond those of domestic stock:

Exam Tip: Gotchas

ADRs eliminate the need for U.S. investors to transact in foreign currencies directly, but they do NOT eliminate currency risk. The underlying shares are still denominated in the foreign currency, and exchange rate changes affect the ADR's value and dividend payments.