Characteristics of Common Stock
Now that you understand how shares are classified, let's look at what common stock actually represents and the fundamental characteristics that define it as a security.
Ownership Representation
- Common stock represents an equity ownership interest (residual claim) in a corporation
- "Residual" means common stockholders are the last to receive distributions in the event of corporate liquidation, after creditors, bondholders, and preferred stockholders
- Common stock has no maturity date; ownership continues until shares are sold or the company is dissolved
- This unlimited time horizon, combined with the residual claim, is what gives common stock both its greatest risk and its greatest upside potential (unlimited appreciation)
Limited Liability
- Shareholders' maximum loss is limited to their total investment (the purchase price of their shares)
- Creditors of the corporation cannot pursue shareholders' personal assets
- This is one of the fundamental advantages of the corporate structure; risk is capped at what you put in
Exam Tip: Gotchas
Limited liability means you can lose 100% of your investment, but not more. If a corporation goes bankrupt owing millions, shareholders lose their investment but are not personally liable for the company's debts.
Transferability
- Common stock is freely transferable on the secondary market
- Exception: shares subject to restrictions such as Rule 144 for control stock or restricted stock may have holding period and volume limitations
- Two key entities facilitate the transfer process:
| Entity | Role | Key Function |
|---|---|---|
| Transfer agent | Maintains shareholder records | Cancels old certificates, issues new ones, handles lost or destroyed certificates, distributes dividends |
| Registrar | Audits the transfer agent | Ensures the corporation does not issue more shares than authorized; typically a bank or trust company |
Transfer agent responsibilities:
- Record changes of ownership
- Maintain the issuer's security holder records (the official corporate shareholder registry)
- Cancel and issue certificates
- Act as paying agent for dividends
- Send proxy materials and other corporate communications
- May serve as inspector of elections at shareholder meetings
Registrar responsibilities:
- Audit the transfer agent's work
- Verify share counts to prevent over-issuance
- Always a separate entity from the transfer agent (independence requirement)
Exam Tip: Gotchas
The transfer agent maintains records and handles the mechanics of ownership changes. The registrar's job is narrower; it audits the transfer agent to make sure the company doesn't issue more shares than authorized. They must be separate entities.