Quick Answer
Common stock is a residual ownership interest carrying voting, pre-emptive, and last-in-line liquidation rights. Shares nest as authorized, then issued, then outstanding, with treasury stock issued but not outstanding. Spinoffs split cost basis, mergers substitute it, and penny stocks (unlisted and under $5) trigger layered disclosure and a signed suitability statement.
The whole unit on one sheet: how shares are classified, what owners are entitled to, how corporate actions move stock around, and the penny stock rules the exam loves.
Share Classifications: The Nested Hierarchy
- Authorized: maximum shares the corporate charter permits; raising it needs a shareholder vote.
- Issued: shares sold to investors at any point; includes shares still held AND shares bought back.
- Outstanding: shares currently held by all investors. Outstanding = Issued minus Treasury.
- Treasury stock: repurchased shares; issued but NOT outstanding. Does not vote, gets no dividends, excluded from earnings per share (EPS). Can be reissued or retired (retiring cuts the issued count).
- The rule of thumb: Authorized >= Issued >= Outstanding.
The One-Liners That Win Points
- Common stock is a residual claim: last in line at liquidation, which means greatest risk but unlimited upside.
- Limited liability: most a shareholder can lose is the total investment; creditors cannot reach personal assets.
- Statutory voting = one vote per share per seat, best for majority holders. Cumulative voting = shares x seats pooled onto any candidates, best for minority holders.
- Pre-emptive rights let owners buy a proportionate share of new stock to avoid dilution, but only if the charter grants them.
- The board has no legal obligation to declare common dividends, unlike cumulative preferred.
- Transfer agent handles ownership records and certificates; the registrar audits it to prevent over-issuance. They must be separate entities.
- Spinoff: basis is SPLIT by relative fair market value (FMV). Merger: old basis is SUBSTITUTED (carries over). Both tack on the holding period.
- Penny stock = unlisted AND under $5. A $3 stock on the New York Stock Exchange (NYSE) is NOT a penny stock.
Numbers to Lock In
| Item | Value |
|---|---|
| Penny stock price ceiling | below $5 per share |
| EPS / book value per share denominator | outstanding shares |
| Cumulative votes | shares owned x number of open seats |
| Penny stock exemption: net tangible assets, 3+ years operating | over $2 million |
| Penny stock exemption: net tangible assets, under 3 years | over $5 million |
| Penny stock exemption: average revenue, last 3 years | over $6 million |
| Suitability-statement exemption: account age | more than 1 year |
| Suitability-statement exemption: prior penny stock buys | 3 or more |
| Tax-free spinoff: subsidiary stock distributed | at least 80% |
Top Gotchas
- Treasury stock is issued but NOT outstanding. With 10 million authorized, 8 million issued, and 1 million treasury: 7 million outstanding, 2 million still issuable, and 1 million reissuable.
- Par value has no relationship to market value. A $0.01 par stock can trade at $500.
- In liquidation, common is LAST: secured creditors, unsecured creditors (including bondholders), preferred, then common.
- Pre-emptive rights are not automatic; the charter must grant them.
- A spinoff is not free stock. Original basis is reallocated proportionally, and the parent's holding period tacks on.
- Loss is NEVER recognized in a reorganization, even with boot; gain is recognized only up to the boot received.
- The suitability-statement exemptions (1+ year account OR 3+ prior penny stock purchases) waive ONLY the suitability statement; the signed risk disclosure document, quotation disclosure, compensation disclosure, and monthly statements still apply to every penny stock trade.
One-Breath Recap
Common stock is a voting, residual ownership interest that sits last in liquidation for the greatest risk and unlimited upside. Shares nest as authorized over issued over outstanding, with treasury stock issued but silent. Spinoffs split basis by fair market value while mergers carry it over, and any unlisted stock under $5 drags in the penny stock disclosure package and a signed suitability statement.
Need more than the recap? This is a condensed summary. If it is not enough, read the full Common Stock unit for the complete lesson.