Rights of Common Stockholders
With an understanding of what common stock is and how it's structured, you can now explore the specific rights that come with ownership. These rights are among the most frequently tested topics in the equity section.
Voting Power
Common stockholders vote on major corporate decisions, including:
- Election of the board of directors
- Stock splits (forward and reverse)
- Mergers, acquisitions, and consolidations
- Issuance of additional shares or convertible securities
- Changes to the corporate charter or bylaws
- Other extraordinary corporate actions
Shareholders may vote in person at annual meetings or by proxy (written authorization for someone else to vote on their behalf).
Voting Methods
| Voting Method | How It Works | Who Benefits |
|---|---|---|
| Statutory (regular) voting | One vote per share, per open seat; votes cannot be transferred between candidates | Majority shareholders - each seat is a separate election |
| Cumulative voting | Total votes = shares owned x number of seats; all votes may be concentrated on one candidate | Minority shareholders - allows concentrated support |
| Nonvoting stock | Some classes of common stock carry no voting rights | The company - raises capital without diluting control |
Cumulative Voting Example
A shareholder owns 100 shares and 3 board seats are being elected:
- Statutory voting: maximum 100 votes per candidate (votes cannot be pooled)
- Cumulative voting: 100 shares x 3 seats = 300 total votes, all of which can be cast for a single candidate
This pooling ability is what makes cumulative voting powerful for minority shareholders. Several minority shareholders can coordinate to elect at least one director, even if they collectively own less than half the shares.
Exam Tip: Gotchas
- Cumulative voting benefits MINORITY shareholders. A shareholder with 100 shares voting on 3 board seats can cast all 300 votes for one candidate. Statutory voting limits that same shareholder to 100 votes per seat.
Pre-emptive Rights
- The right to purchase a proportionate share of newly issued stock before it is offered to the public
- Purpose: allows existing shareholders to maintain their percentage ownership (prevent dilution)
- Pre-emptive rights are exercised through rights offerings (also called subscription rights)
- Not all corporations grant pre-emptive rights; it depends on the corporate charter
Example: If you own 5% of a company and it issues 1 million new shares, pre-emptive rights let you buy 50,000 shares (5%) at the subscription price before the public offering.
Exam Tip: Gotchas
- Pre-emptive rights are NOT automatic. The corporate charter must specifically grant them. Not all companies offer this protection.
Pro Rata Share of Dividends
- Common stockholders receive dividends only if declared by the board of directors
- The board has no legal obligation to declare dividends on common stock (unlike cumulative preferred stock, where skipped dividends accumulate)
- Dividends are distributed in proportion to shares owned (pro rata)
Types of dividends:
| Type | What Is Distributed | Tax Implications |
|---|---|---|
| Cash dividends | Cash payment per share | Taxable in the year received |
| Stock dividends | Additional shares of the company's stock | Not taxable when received; adjusts cost basis |
| Property dividends | Non-cash assets (rare) | Taxable at fair market value |
Exam Tip: Gotchas
- The board has NO legal obligation to declare common stock dividends. Unlike cumulative preferred stock (where skipped dividends accumulate), the board can skip common dividends indefinitely with no obligation to make them up.
Access to Corporate Books and Records
- Shareholders have the right to inspect corporate books and records, including financial statements and shareholder lists
- This right must be exercised for a proper purpose (e.g., communicating with fellow shareholders, investigating suspected mismanagement)
- A shareholder cannot demand records for harassment or competitive purposes
Residual Claim on Corporate Assets
In liquidation, common stockholders receive whatever remains after all senior claims are satisfied.
Liquidation priority (highest to lowest):
| Priority | Claimant | Notes |
|---|---|---|
| 1 | Secured creditors | Claims backed by specific assets |
| 2 | Unsecured creditors (including bondholders) | General claims on corporate assets |
| 3 | Preferred stockholders | Senior to common; may have par value claim |
| 4 | Common stockholders | Residual claim - whatever is left |
- Common stockholders bear the greatest risk in a corporate liquidation
- However, they also have the greatest upside potential - stock appreciation is theoretically unlimited
- This risk/reward tradeoff is fundamental to understanding equity securities
Exam Tip: Gotchas
- In liquidation, common stockholders are LAST. The priority is: secured creditors, unsecured creditors (including bondholders), preferred stockholders, then common stockholders. Last in line means greatest risk, but also unlimited upside.