How Common and Preferred Stock Work, Where They Rank, and What the Exam Tests

Common stock gives shareholders ownership, voting rights and a claim on whatever profits and assets remain after everyone else is paid. Preferred stock usually gives up the vote in exchange for a fixed dividend and priority over common shareholders, both for dividends and for any money returned if the company is liquidated.

Both are equity, so both sit behind a company’s bondholders and other creditors. The difference is where each one stands in the line, and what its holders give up or gain to be there.

This guide covers how each type works, the main kinds of preferred stock, the rules on voting and dividends, worked examples, a client scenario, the exam traps candidates fall for and five practice questions with explanations. Preparing for your exam? Explore every FRC video playlist and choose the exam topics you want to master first, with exam traps called out in every topic.

What Common Stock Gives You

Common stock is the basic unit of ownership in a corporation. Each share represents a proportional stake in the company, and its value rises and falls with the company’s prospects.

Common shareholders have a residual claim. They are entitled to what is left after the company has paid its employees, suppliers, lenders, bondholders and preferred shareholders, which means they carry the most risk but also have the most to gain if the company grows.

Common shareholders also have limited liability. The most they can lose is what they paid for their shares, even if the company’s debts exceed its assets.

Where This Topic Appears on the Series 65

Equity securities are a core part of the Series 65, alongside the client recommendations built on them. Questions test shareholder rights, the features of different types of preferred stock, dividend calculations and which security suits which client.

FRC’s Series 65 Exam Preparation course covers equity and fixed income securities, their risks and their suitability for different clients, and the exam requires no sponsor. The SIE Examination Preparation course covers common and preferred stock as part of the exam you can pass before you are hired.

Every FRC course can be spread across interest-free monthly payments, so cost is no reason to delay. Equity basics are among the most dependable marks on both exams once the rights and rankings are clear.

The Rights of Common Shareholders

Common shareholders generally have the right to vote on major corporate matters, including electing the board of directors, approving mergers and authorizing stock splits. They do not vote on day-to-day decisions such as dividend payments, which are set by the board.

They also have the right to receive dividends if the board declares them, to transfer their shares freely, and to inspect certain corporate books and records. Some companies grant preemptive rights, which let existing shareholders buy new shares before they are offered to the public, so they can maintain their percentage of ownership.

Those preemptive rights are usually offered through a rights offering. Each existing share receives a right that allows the holder to buy new shares, typically at a price below the current market price.

Statutory and Cumulative Voting

Under statutory voting, a shareholder can cast one vote per share for each seat on the board. A shareholder with 100 shares and three seats up for election can cast up to 100 votes for each of three candidates.

Under cumulative voting, the shareholder multiplies their shares by the number of seats and can distribute those votes however they choose. The same shareholder would have 300 votes and could cast all 300 for a single candidate.

Cumulative voting benefits minority shareholders, because it gives them a better chance of electing at least one director. This is a regular exam question, so remember the multiplication and who it helps.

How Common Stock Dividends Work

Common stock dividends are not guaranteed. The board decides whether to pay them, how much to pay and when, and it can cut or stop them at any time.

Many growing companies pay no dividend at all, reinvesting their profits instead. Mature companies with steady earnings are more likely to pay regular dividends, which they may raise over time.

Returns on common stock come from two sources: dividends and capital appreciation, the rise in the share price. Because there is no fixed payment, common stock prices respond mainly to the company’s earnings and growth prospects rather than directly to interest rates.

The Four Dividend Dates

Every dividend, common or preferred, follows four dates. The declaration date is when the board announces the dividend, the record date is when the company checks who its shareholders are, and the payment date is when the money is paid.

The fourth date, the ex-dividend date, decides who actually receives it. An investor who buys on or after the ex-date does not get the dividend; the seller does.

Since US stock trades moved to T+1 settlement in May 2024, the ex-dividend date for regular-way trades is generally the same day as the record date. On the ex-date, the share price typically falls by roughly the amount of the dividend, because new buyers are no longer entitled to it.

What Preferred Stock Gives You

Preferred stock is a hybrid. It is equity, so it represents ownership, but it behaves in many ways like a bond, paying a fixed dividend based on a stated percentage of its par value.

A preferred share with a par value of $100 and a 6% dividend rate pays $6 a year per share, usually in quarterly installments. Many exchange-traded preferred shares have a par value of $25 instead.

Preferred shareholders usually have no voting rights. In exchange, they receive their dividends before common shareholders receive anything, and they rank ahead of common shareholders if the company is liquidated.

Where Each Ranks in Liquidation

If a company is liquidated, its assets are paid out in a strict order of priority. Secured creditors come first, followed by unsecured creditors, including bondholders and holders of debentures, then subordinated debt holders.

Preferred shareholders come next, and common shareholders come last. Common shareholders receive only what is left, which in many bankruptcies is nothing.

That ranking explains the risk and return profile of each security. Preferred stock is generally less risky than common stock but riskier than the same company’s bonds, and its holders give up most of the upside that common shareholders enjoy.

Cumulative and Non-Cumulative Preferred Stock

The most heavily tested feature is whether preferred dividends are cumulative. If a company skips a dividend on cumulative preferred stock, the missed payment builds up as dividends in arrears, and the company must pay all arrears before it can pay any dividend to common shareholders.

Non-cumulative preferred stock carries no such protection. If the board skips a dividend, it is gone for good, and the company can resume paying common dividends as soon as it pays the current preferred dividend.

Because cumulative preferred stock offers more protection, it typically pays a lower dividend rate than otherwise similar non-cumulative preferred stock.

Other Types of Preferred Stock

Callable preferred stock can be bought back by the company at a set price after a certain date. Companies tend to call it when interest rates fall, so investors face call risk, and callable preferred usually pays a higher dividend to compensate.

Convertible preferred stock can be exchanged for a set number of common shares. That gives holders a share in the company’s growth, so it usually pays a lower dividend than non-convertible preferred. FRC’s guide to how to calculate conversion parity explains how its value is linked to the common share price.

Participating preferred stock can receive extra dividends beyond its stated rate when the company performs well, and adjustable-rate preferred stock has a dividend that resets periodically based on a benchmark interest rate. Because its payment moves with rates, adjustable-rate preferred tends to have a more stable price than fixed-rate preferred.

Why Preferred Stock Prices Move With Interest Rates

Fixed-rate preferred stock pays the same dividend year after year, so its price behaves much like a bond’s. When interest rates rise, newly issued securities pay more, so existing preferred shares fall in price until their yield is competitive.

When interest rates fall, existing preferred shares become more attractive and their prices rise, although callable preferred may be called away before investors benefit fully. That is the same interest rate and call risk bond investors face.

Some preferred shares have no maturity date at all, known as perpetual preferred. Their prices can be especially sensitive to interest rate changes, much like long-term bonds.

How Dividends Are Taxed

For individual investors, dividends from both common and preferred stock may count as qualified dividends, taxed at the lower long-term capital gains rates if the investor meets the holding period requirements. Otherwise, they are taxed as ordinary income.

Corporations get an additional benefit. Under the dividends received deduction, a corporation that owns shares in another corporation can deduct a portion of the dividends it receives, 50% if it owns less than 20% of the paying company, 65% if it owns 20% or more but less than 80%, and 100% if it owns 80% or more.

That deduction makes preferred stock particularly attractive to corporate investors seeking income. It is a common exam question precisely because individual investors cannot use it.

Comparing Common and Preferred Stock

The table below summarizes the main differences.

Worked Example: Dividends in Arrears

A company has 6% cumulative preferred stock with a par value of $100, which pays $6 a share each year. Facing losses, the company skips its preferred dividend for two years.

In year three, the company wants to resume paying a dividend to common shareholders. Before it can, it must pay the two years of arrears plus the current year’s dividend, a total of $18 per preferred share.

If the preferred stock were non-cumulative, the company would only need to pay the current year’s $6. The two missed payments would be lost, and the common dividend could resume immediately afterward.

Worked Example: Cumulative Voting

A shareholder owns 500 shares, and four seats on the board are up for election. Under statutory voting, they can cast up to 500 votes for each of four candidates.

Under cumulative voting, they have 500 multiplied by four, or 2,000 votes. They could cast all 2,000 for a single candidate, or split them in any combination across the four seats.

That concentration is why cumulative voting gives minority shareholders a stronger voice in electing at least one director.

Client Scenario: Income for a Retired Client

A retired client wants steady income and asks an investment adviser representative whether to buy a company’s common stock, its fixed-rate callable preferred stock or its bonds. The client is concerned about losing capital.

The adviser should explain that the preferred stock offers a higher, fixed dividend than the common stock and ranks ahead of it, but sits behind the company’s bonds if things go wrong. Its price will fall if interest rates rise, and the company may call it if rates fall, which would cap any price gain.

A suitable recommendation depends on the client’s need for income, tolerance for price swings and the credit quality of the company. As a fiduciary, the adviser must put the client’s interests first; FRC’s guide to fiduciary standard vs suitability standard explains what that duty requires.

The Exam Traps

The first trap is assuming preferred dividends are guaranteed. They are not; the board can skip them, and cumulative preferred only means the missed payments must be made up before common shareholders are paid.

The second trap is the ranking. Preferred stock ranks ahead of common stock but behind every creditor, including bondholders, so it is not as safe as the same company’s debt.

The third trap is voting. Common shareholders vote, preferred shareholders usually do not, and cumulative voting multiplies shares by seats to help minority shareholders. The fourth trap is the dividends received deduction, which benefits corporations, not individual investors.

A Memory Aid

Think of common stock as owning the house with a mortgage. You make the decisions and you keep every gain once the lender is paid, but if the value falls, you take the first loss.

Think of preferred stock as being a silent partner on a fixed share of the profits. You are paid a set amount before the owner takes anything, and you stand ahead of the owner if the house is sold to pay its debts, but you have no say in how it is run and you do not share in its rise in value.

Practice Questions

Question one: a company has 5% cumulative preferred stock with a $100 par value and has skipped its dividend for three years. How much must it pay per preferred share before paying a common dividend this year? It must pay $20, made up of $15 in arrears and $5 for the current year.

Question two: a shareholder owns 200 shares and five board seats are up for election under cumulative voting. How many votes can they cast? They can cast 1,000 votes, which they can distribute among the candidates however they choose.

Question three: in a liquidation, who is paid first: preferred shareholders or bondholders? Bondholders, because they are creditors and rank ahead of all equity holders.

Question four: which type of preferred stock typically has the most stable price when interest rates change? Adjustable-rate preferred stock, because its dividend resets with a benchmark interest rate.

Question five: why is preferred stock often attractive to corporate investors? Because of the dividends received deduction, which allows a corporation to deduct a portion of the dividends it receives from another corporation.

Related Questions

Common and preferred stock connect to several other Series 65 topics. FRC’s guide to callable vs non-callable bonds explains the call risk that also applies to callable preferred stock, and the guide to investment-grade vs high-yield bonds covers the credit quality that shapes how preferred stock is priced.

Together with the conversion parity guide linked above, they give you a complete picture of how equity and hybrid securities are structured and valued.

Get Exam-Ready

Equity securities are among the most dependable marks on the Series 65 once shareholder rights, preferred stock features and liquidation rankings are clear. The FRC video playlists linked at the top of this guide cover every exam section, with the traps to look out for in each one.

The FRC dictionary is more than a dictionary. It is a library of explainer videos, written explanations and on-page quizzes covering the FINRA and SEC rules you are tested on, so you can open any rule and go deeper whenever a question catches you out.

Study With FRC

FRC’s programs and memberships are open to everyone. Whether you are preparing for the Series 65, the SIE or both, structured exam preparation turns topics like voting rights and dividends in arrears into marks you can rely on.

FRC’s Professional Membership adds verified progress and a Digital Profile, so when you apply for roles, employers can see your exam progress and the knowledge you are building, not just read about it on a resume.

Your Next Step

Common stock gives ownership, voting rights and the full upside, but its holders are paid last. Preferred stock gives a fixed dividend and priority over common shareholders, usually without a vote, and its price moves with interest rates much like a bond.

Master the liquidation order, cumulative dividends and cumulative voting, and you will be ready for every version of this question the exam can ask.