Stock

The two primary categories of stock — common stock and preferred stock — have distinct rights structures, distinct positions in the capital structure, and distinct investment characteristics that are among the most foundational topics tested on the SIE and Series 7 examinations.

The Corporate Structure — Why Stock Exists

The corporate form of business organisation — established under state corporation law in every United States jurisdiction and internationally under equivalent statutory frameworks — creates a legal entity that is separate and distinct from its owners.

A corporation can own property, enter contracts, sue and be sued, and incur obligations in its own name, independently of the individuals who own its stock.

This separation of the corporation from its owners produces the defining characteristic of corporate stock ownership — limited liability — the principle that a shareholder's financial exposure is limited to the amount invested in the stock, regardless of how large the corporation's obligations become.

Limited liability is the foundational economic justification for the stock form of ownership. Without it, investors would be reluctant to hold stock in large corporations whose potential liabilities they cannot monitor or control — the unlimited personal liability that characterises partnership ownership makes it impractical as a structure for raising capital from large numbers of passive investors.

Limited liability enables the separation of ownership from management — shareholders can own pieces of corporations without having to participate in their operation — and makes possible the diversified investment across many corporations that Modern Portfolio Theory identifies as the rational strategy for risk-averse investors.

A corporation's stock is authorised by its articles of incorporation — the foundational charter document filed with the state of incorporation — which specifies the total number of shares the corporation is permitted to issue across all classes.

The authorised share count establishes the ceiling on the corporation's equity capital structure. The issued shares — those actually distributed to shareholders — may be less than the authorised total.

Shares that have been issued and subsequently repurchased by the corporation are called treasury shares — they are issued but not outstanding, carrying no voting rights or dividend entitlement while held by the corporation. Outstanding shares — issued shares minus treasury shares — are the shares held by investors and used in earnings per share, book value per share, and other per-share financial calculations.

Common Stock — The Primary Equity Instrument

Common stock is the primary and most widely distributed form of corporate equity — the security most investors mean when they refer to a company's stock without qualification. Common stockholders are the residual owners of the corporation — they receive whatever economic value remains after all other claims against the corporation have been satisfied.

Voting rights are the most fundamental governance right of common stockholders. Common shareholders typically receive one vote per share on all matters submitted to a shareholder vote — including the election of directors to the corporation's board, the approval of major corporate transactions including mergers, acquisitions, and asset sales, the ratification of the independent auditor, and advisory votes on executive compensation mandated by the Dodd-Frank Act's Section 951 say-on-pay requirements.

Directors are elected by majority vote or — in some corporate governance structures — by plurality vote in uncontested elections. Some corporations maintain dual-class stock structures — discussed in the Dual Class Stock entry of this dictionary — in which founder or management-held shares carry multiple votes per share while publicly distributed shares carry one vote per share, concentrating voting control without requiring concentrated economic ownership.

The right to elect the board of directors is the cornerstone of common stockholder governance — the board is the highest governing authority of the corporation and is responsible for hiring and overseeing executive management, approving major strategic decisions, and ensuring that the corporation is operated in the interests of shareholders.

The board's accountability to shareholders is the formal mechanism through which the separation of ownership from management is governed — shareholders cannot directly manage the corporation but can elect representatives who are legally obligated to act as fiduciaries in the corporation's and shareholders' collective interest.

Dividend rights for common stockholders are discretionary rather than mandatory — common shareholders have no legal right to receive a dividend unless and until the board of directors declares one. 

Dividends must be declared by the board from funds legally available for the purpose — typically the corporation's retained earnings and, in some states, paid-in capital above par value — and the board has complete discretion over whether to declare dividends, in what amount, and on what schedule.

A corporation that has consistently paid quarterly dividends has no legal obligation to continue doing so — the board may reduce, suspend, or eliminate dividends at any time it deems appropriate, subject only to any covenants in debt agreements restricting dividend payments. 

This discretionary nature of common dividends contrasts with the mandatory nature of preferred dividends, discussed below.

Liquidation rights of common stockholders are residual — in a corporate liquidation or bankruptcy, common shareholders receive whatever assets remain after all creditors and preferred stockholders have been paid in full.

The liquidation priority order runs from secured creditors — who have specific asset collateral securing their claims — to unsecured senior creditors — who have first priority among general creditors — to subordinated creditors — who rank below senior unsecured claims — to preferred stockholders — who have priority over common in both dividends and liquidation — to common stockholders — who receive whatever, if anything, remains. In most corporate liquidations that involve significant financial distress, common stockholders receive little or nothing — the corporation's assets are exhausted satisfying creditor claims before any residual reaches equity.

Preferred Stock — The Hybrid Security

Preferred stock occupies the capital structure between common equity and debt — it is legally classified as equity but possesses characteristics — fixed dividend rights, priority over common in dividends and liquidation, and often a face or par value — that give it economic characteristics similar to debt.

The complete characteristics of preferred stock are covered in the Preferred Stock entry of this dictionary — the present entry addresses preferred stock's relationship to common stock in the context of the overall stock concept.

Preferred dividends are typically fixed — either a specified dollar amount per share or a specified percentage of par value — and must be paid before any common dividend may be declared. The priority nature of preferred dividends is their defining advantage — preferred shareholders do not share in the corporation's profit growth the way common shareholders do, but they receive their stated dividend before common shareholders receive anything.

Cumulative preferred dividends — the most common type — accumulate when unpaid and must be paid in full before any common dividend can be declared, creating an arrear that the corporation must satisfy in future periods even if it was unable to pay the preferred dividend in the current period.

Liquidation preference is the second major advantage of preferred stock — in liquidation, preferred stockholders receive their stated liquidation value — typically par value plus accrued and unpaid dividends — before common stockholders receive anything.

This preference over common equity in liquidation reflects the quasi-debt nature of preferred stock — preferred holders have given up the upside of common equity growth in exchange for priority claim in adverse scenarios.

Convertible preferred stock — particularly prevalent in venture capital and private equity financing — carries the right to convert each preferred share into a specified number of common shares at the holder's option. 

This conversion feature provides preferred investors with downside protection through the liquidation preference and dividend priority while preserving the ability to participate in upside value creation by converting to common stock if the corporation's value grows sufficiently.

Voting rights of preferred stockholders are typically limited or absent — most preferred stock does not carry ordinary voting rights and preferred holders typically do not vote for directors or on general corporate matters. However, preferred shares commonly carry conditional voting rights that are triggered by specific adverse events — typically the failure to pay preferred dividends for a specified number of consecutive periods, at which point the preferred holders acquire the right to elect a specified number of directors until the dividend arrearage is cured.

The Capital Structure Hierarchy — Stock's Position

Understanding stock's position in the corporate capital structure is essential for understanding the risk and return characteristics of equity investment and for applying the concepts tested on securities licensing examinations.

In the capital structure hierarchy from least to most risk and from highest to lowest priority:

Secured debt holders have the first claim on specific identified assets pledged as collateral for their loans. In a liquidation, the secured lender's collateral is sold first and the proceeds applied to the secured obligation before any other claim is addressed.

Senior unsecured creditors — holders of investment grade bonds and bank term loans without specific asset collateral — rank below secured creditors but above all other unsecured claims. They are entitled to payment from the corporation's general assets after secured claims but before subordinated claims.

Subordinated debt holders — including high yield bond investors — rank below senior unsecured creditors but above equity. In bankruptcy, subordinated creditors typically receive something — partial recovery on their face value claims — while equity often receives nothing.

Preferred stockholders rank below all debt holders but above common equity. They receive their liquidation preference before common stockholders receive anything.

Common stockholders rank last — the residual claimants who receive whatever value remains after every other claim in the capital structure has been satisfied. This junior position explains why common stock carries both the greatest risk — it is the first to be wiped out in financial distress — and the greatest return potential — it is the primary beneficiary of a corporation's success because every dollar of value created above all senior claims belongs to common equity holders.

The Statutory Framework — Securities Exchange Act Section 12

A company's stock becomes subject to the full disclosure, governance, and regulatory framework of the Securities Exchange Act of 1934 when the stock is registered under Exchange Act Section 12.

Securities are subject to Section 12 registration in two circumstances — when the stock is listed on a national securities exchange, or when the stock is held by more than two thousand holders of record and the company has total assets above ten million dollars under the Dodd-Frank Act-adjusted thresholds.

Upon registration under Section 12, the company and its stockholders become subject to the full suite of Exchange Act obligations — periodic reporting on Forms 10-K, 10-Q, and 8-K under Section 13(a); proxy solicitation rules under Section 14 governing the shareholder voting process including notice requirements, the content of proxy statements, and the say-on-pay and say-on-frequency votes required by Dodd-Frank; beneficial ownership reporting under Section 13(d) and 13(g) for holders of more than five percent of a registered class; insider transaction reporting under Section 16 requiring Form 4 filing within two business days of any change in insider beneficial ownership; and the short-swing profit disgorgement obligation of Section 16(b) applicable to officers, directors, and ten percent stockholders.

The registration of equity securities under the Exchange Act is the pivotal transformation that converts a private company — whose stock is subject to minimal regulatory disclosure requirements — into a public company subject to the most comprehensive corporate transparency regime in the world.

Stock Valuation — The Fundamental Analytical Framework

The value of a share of stock is the present value of all future cash flows the investor expects to receive — dividends during the holding period and the proceeds from the eventual sale of the shares. This discounted cash flow framework, applied to stocks through the Dividend Discount Model and related equity valuation approaches, connects the abstract concept of stock ownership to concrete financial analysis.

The Dividend Discount Model — covered in its own entry in this dictionary — values a stock as the present value of all expected future dividends, discounted at the required rate of return determined by the Capital Asset Pricing Model. In its simplest constant growth form — the Gordon Growth Model — the stock price equals the next expected dividend divided by the required rate of return minus the expected perpetual growth rate of dividends.

This formula reveals the inverse relationship between required return and stock value — as the required return rises, the stock price falls — and connects Federal Reserve monetary policy directly to equity valuations through the interest rate's effect on required returns.

Price-to-earnings and price-to-book multiples — covered in the Price to Earnings Ratio and Price to Book Ratio entries of this dictionary — provide relative valuation comparisons that supplement the absolute valuation framework of discounted cash flow. Fundamental analysis — the examination of a company's financial statements, competitive position, management quality, and industry dynamics to assess intrinsic value — and technical analysis — the study of price and volume patterns in historical trading data to identify buying and selling opportunities — are the two primary analytical frameworks that investors apply to stock selection.

The Primary and Secondary Market for Stock

Stock is initially distributed to investors in the primary market — through an initial public offering, a follow-on offering, a direct listing, or a private placement — in transactions in which the corporation receives the capital raised. After initial distribution, stock trades in the secondary market among investors — on national securities exchanges, alternative trading systems, and over-the-counter markets — in transactions in which the proceeds flow to the selling investor rather than to the corporation.

The secondary market trading of stock provides the liquidity that makes stock a practical investment for the vast majority of investors — without the ability to sell, stock ownership would be an illiquid long-term commitment to a single company's fortunes that most investors could not accept. The existence of deep and liquid secondary markets for stock is what makes the primary market effective — investors are willing to purchase newly issued stock at IPOs precisely because they know they can sell in the secondary market if they need to.

Working a Liquidation Through the Hierarchy

The hierarchy set out above is a strict order of payment rather than a sharing arrangement, and the arithmetic of a single liquidation shows what that means for each class. Suppose Calder Industrial Corporation is wound up and its assets realise four hundred and twenty million dollars. Its secured lender holds a claim of one hundred and fifty million dollars against pledged collateral, its senior unsecured bondholders hold two hundred million dollars, its subordinated noteholders hold one hundred and twenty million dollars, and its two million preferred shares carry a stated liquidation value of fifty dollars a share — one hundred million dollars in total — ranking ahead of forty million common shares. The secured claim is satisfied first and takes one hundred and fifty million dollars, leaving two hundred and seventy million. The senior unsecured claims are satisfied next and take two hundred million, leaving seventy million. The subordinated noteholders are the next class in the order, and seventy million dollars is the whole of what remains against their claim of one hundred and twenty million — a recovery of about fifty-eight percent measured against the face amount of their claim, with the entire fifty million dollar shortfall falling on that one class while every class ranking above it has been paid in full.

The preferred stockholders and the common stockholders receive nothing from that estate, and they receive nothing on the same footing. The liquidation preference is a priority over the common stock and not a claim ranking ahead of the corporation's creditors, so where an estate is exhausted before the equity layer is reached at all, a stated preference is worth no more than the residual claim it outranks. The one hundred million dollars of stated liquidation value in the example measures what the preferred holders would have taken had the estate reached them; it is not a sum they can claim out of assets already committed to creditors who rank above them.

The same arithmetic identifies the estate value at which the common stockholders first receive anything. The debt claims in the example total four hundred and seventy million dollars — one hundred and fifty, two hundred, and one hundred and twenty — and the preferred stock's stated liquidation value adds a further one hundred million, so an estate of five hundred and seventy million dollars satisfies every claim ranking ahead of the common stock and leaves the common stockholders with nothing whatever. An estate of five hundred and eighty million dollars leaves ten million dollars for the forty million common shares, which is twenty-five cents a share. The common stockholders' recovery therefore begins only above the sum of all debt and the whole of the preferred stock's liquidation value, which is why a residual claim can be worth nothing in one liquidation and a substantial amount in another whose estate is only modestly larger.

The Required Return and the Growth Rate — Working the Constant Growth Formula

Because the constant growth form divides the next expected dividend by the required rate of return less the expected perpetual growth rate, the whole of the formula's sensitivity sits in the spread between those two rates rather than in the level of either one. Take a share whose next expected annual dividend is two dollars and forty cents, with a required return of nine percent and expected dividend growth of four percent: the spread is five percentage points and the value is 2.40 divided by 0.05, or forty-eight dollars. Raise the required return by one percentage point to ten percent and the spread widens to six points, giving 2.40 divided by 0.06, or forty dollars — a fall of eight dollars, which is about sixteen and two-thirds percent of the original value. Now take the same dividend with a required return of fourteen percent and the same four percent growth: the value is 2.40 divided by 0.10, or twenty-four dollars, and the identical one percentage point rise in the required return gives 2.40 divided by 0.11, or twenty-one dollars and eighty-two cents — a fall of about nine percent. The same movement in the required return costs nearly twice as much in proportional terms where the spread was narrow, because one percentage point is a far larger fraction of a five point denominator than of a ten point one.

The same observation explains why the formula treats an improvement in expected growth and a reduction in the required return as interchangeable. Holding the next expected dividend at two dollars and forty cents and the required return at nine percent, raising expected growth from four percent to five percent narrows the spread to four points and gives 2.40 divided by 0.04, or sixty dollars. Holding expected growth at four percent instead and reducing the required return from nine percent to eight percent narrows the spread to the same four points and gives the same sixty dollars. Neither rate enters the formula except through the difference between them, so one percentage point of additional expected dividend growth and one percentage point off the return investors demand are worth precisely the same amount on this measure.

A reader may object that the value of a share was described as the present value of the dividends received during the holding period together with the proceeds of the eventual sale, while the constant growth formula mentions no sale at all. The arithmetic reconciles the two descriptions. A holder of the share valued at forty-eight dollars above receives two dollars and forty cents of dividend over the coming year, and by the end of that year the next expected dividend has grown by four percent to 2.496, so the same formula applied one year later gives a price of 2.496 divided by 0.05, or forty-nine dollars and ninety-two cents. The holder's total expected receipt at the end of the year is therefore fifty-two dollars and thirty-two cents, and discounting that single sum at the nine percent required return gives 52.32 divided by 1.09, which is forty-eight dollars exactly. The expected sale price is not a separate assumption that has to be supplied from outside: it is the same valuation carried out one period later, which is why the formula values the whole stream without asking how long the holder intends to hold the share.

The Outstanding Share Count in Practice — What Each Calculation Is Struck On

Take a corporation whose charter authorises two hundred million shares, which has issued one hundred and twenty million of them and holds twenty million of those in treasury, leaving one hundred million shares outstanding. Because treasury shares carry no dividend entitlement while the corporation holds them, a dividend the board declares is paid only on the shares outstanding, and the cash the declaration costs the corporation is the amount declared per share multiplied by that count: a dividend of sixty cents a share costs 0.60 multiplied by one hundred million, or sixty million dollars. Had the corporation never repurchased the twenty million shares, the same sixty cent dividend would have been paid on one hundred and twenty million shares and would have cost 0.60 multiplied by one hundred and twenty million, or seventy-two million dollars. The twenty million shares in treasury therefore reduce the corporation's aggregate cost by twelve million dollars at every such declaration while changing nothing at all about what any individual shareholder receives, because what the board declares is an amount per share and not an amount in total.

The outstanding count is also the base on which any voting threshold expressed as a proportion of the outstanding shares is struck. Suppose the same corporation's charter requires the affirmative vote of a majority of the outstanding shares to approve a merger. With one hundred million shares outstanding the proposal carries on 50,000,001 shares; before the twenty million shares moved into treasury, when one hundred and twenty million shares were outstanding, the identical charter provision required 60,000,001 shares. Shares the corporation holds in treasury are issued but not outstanding and carry no voting rights, so they drop out of both sides of that calculation, and the number of shares a proponent of the merger has to assemble falls by ten million without a single shareholder's view of the merger having changed.

Control of the board can also move without any change at all in the common stock's voting arithmetic. Suppose the same corporation's one hundred million outstanding common shares elect a board of nine directors, and its preferred stock carries the conditional right, triggered by the failure to pay the preferred dividend for the specified number of consecutive periods, to elect two of those nine directors until the dividend arrearage is cured. On the trigger the common stockholders still hold one hundred million votes and still vote at one vote per share, but they elect seven of the nine seats rather than all nine. No share has been issued, no vote has been lost and no common stockholder's holding has been diluted; the shift in the composition of the board is produced entirely by another class exercising a right that the terms of that class had always given it.

Electing Directors — Where the Voting Rule Comes From and What Its Arithmetic Yields

The method by which a corporation's directors are elected is a matter for the law of the state of incorporation and for the corporation's own charter rather than a feature of common stock as such. Delaware's General Corporation Law, the statute under which a large share of United States public corporations are organised, permits the certificate of incorporation to provide that at all elections of directors of the corporation, or at elections held under specified circumstances, each holder of stock or of any class or classes or of a series shall vote cumulatively. The choice is therefore not a binary one between two regimes for all time: a Delaware certificate may switch cumulative voting on for a defined set of circumstances and leave the ordinary rule in place for every other election of directors.

Where the certificate does provide for it, the cumulative rule entitles the holder to as many votes as the votes the holder would otherwise be entitled to cast for the election of directors multiplied by the number of directors to be elected, and lets the holder cast all of those votes for a single director or distribute them among the candidates as the holder sees fit. The arithmetic that follows from that rule is a consequence of the rule itself and not of the jurisdiction that happens to permit it. Suppose one million shares are entitled to vote, five directors are to be elected, and a holder wants to be certain of electing one of them. Each share carries five votes, so five million votes are cast in all and a holder of n shares commands 5n of them. Placing the whole of 5n on one candidate, the holder is safe unless the majority can lift five candidates of its own above 5n, which takes more than 25n votes in total, and the majority commands 5,000,000 less 5n. The holder's candidate therefore cannot be shut out once 5,000,000 less 5n is no greater than 25n — that is, once 30n reaches 5,000,000 — which first happens at 166,667 shares. At 166,666 shares the majority's 4,166,670 votes still exceed the 4,166,650 it needs and the seat is lost; at 166,667 shares its 4,166,665 votes fall short of the 4,166,675 required and the seat is safe. The threshold is just above the shares voting divided by one more than the number of seats, one million over six, and the same 166,667 shares elect nobody at all under the ordinary rule of one vote per share for each separate seat, where they are outvoted 833,333 to 166,667 in every one of the five elections.

The standard by which the winner of a director election is determined is separately a matter for the charter and the bylaws, and Delaware law protects a choice the stockholders have made from being undone by the board. A bylaw amendment adopted by the stockholders which specifies the votes that shall be necessary for the election of directors may not be further amended or repealed by the board of directors. A board that would prefer a different standard must therefore return to the stockholders rather than make the change itself.

Rights and Options to Acquire Stock From the Corporation

Delaware's corporation law gives a corporation a power distinct from the issuance of stock itself. Subject to any provisions in its certificate of incorporation, every corporation may create and issue rights or options entitling the holders to acquire from the corporation shares of its capital stock of any class, whether or not in connection with the issue and sale of any shares of stock or other securities of the corporation. The numbers, the times and the consideration are as set out in a resolution of the board of directors, and the time at or within which the shares may be acquired on exercise is as stated in the certificate of incorporation or in that resolution and may be limited or unlimited in duration. A right to acquire shares from the corporation therefore need carry no expiry at all, where the instrument creating it fixes none.

The price at which such a right may be exercised is not left wholly to the board. Under the same statute the minimum consideration for which shares of stock may be issued upon exercise of a right or option shall be no less than the consideration required for an issuance of those shares, and shares of stock with par value may be issued only for consideration having a value not less than the par value of the shares so issued. A Delaware corporation whose common stock carries a par value of one dollar a share therefore cannot set the subscription price of a rights offering below one dollar, whatever the market is paying for the stock. If that stock is trading at eighty cents, a holder of one hundred rights in an offering requiring five rights for each new share may subscribe for 100 divided by 5, or twenty shares, and must pay 20 multiplied by 1.00, or twenty dollars, for shares that cost 20 multiplied by 0.80, or sixteen dollars, in the open market. It is the statutory floor under the issue price, rather than any judgement of the board about the discount, that makes such an offering unexercisable.

The power to issue rights and options may be delegated, and the statute fixes in advance what the delegating resolution has to contain. A board resolution delegating to a person or body the authority to issue rights or options must fix the maximum number of shares issuable upon their exercise, a period during which the rights or options and a period during which the shares issuable upon their exercise may be issued, and the minimum consideration for which the rights or options and the shares issuable upon their exercise may be issued; and no such resolution may permit the person or body to issue rights or options to that person or body. The delegation is therefore bounded in quantity, in time and in price before it is given, and it cannot be turned into a grant to the delegate.

Par Value and Legal Capital — What They Constrain and What They Do Not

Par value constrains the price of an original issuance and does not constrain a disposal out of treasury. Under Delaware's corporation law treasury shares may be disposed of by the corporation in the same manner as shares of stock are issued, and the consideration received for treasury shares may have a value greater or less than, or equal to, the par value, if any, of those shares, and may consist of cash, any tangible or intangible property, any benefit to the corporation, or any combination of those. A corporation holding its own one dollar par shares in treasury may therefore sell them for ninety cents, where the same shares could not have been issued originally for less than their par value.

The capital against which such limits are measured is itself a figure the board can move. Delaware's statute defines net assets as the amount by which total assets exceed total liabilities, and surplus as the excess, if any, at any given time, of the net assets of the corporation over the amount determined to be capital; and it provides that the capital may be increased from time to time by resolution of the board of directors directing that a portion of the net assets in excess of the amount so determined to be capital be transferred to the capital account. Suppose a corporation's total assets are nine hundred million dollars and its total liabilities five hundred million, so that its net assets are four hundred million, and that the capital determined in respect of its shares is sixty million: its surplus is three hundred and forty million. A board resolution transferring one hundred million dollars of those net assets to the capital account leaves capital at one hundred and sixty million and surplus at two hundred and forty million. Not a dollar of assets or of liabilities has moved; a resolution of the board has converted one hundred million dollars of surplus into capital.

That capital figure also limits what a corporation may pay to buy in its own shares. Delaware's corporation law provides that no corporation shall purchase or redeem its own shares of capital stock for cash or other property when the capital of the corporation is impaired or when such purchase or redemption would cause any impairment of the capital of the corporation — with the exception that a corporation may purchase or redeem out of capital any of its own shares which are entitled, on any distribution of its assets whether by dividend or in liquidation, to a preference over another class or series of its stock, or, if no shares entitled to such a preference are outstanding, any of its own shares, if those shares will be retired upon acquisition and the capital of the corporation reduced accordingly. A repurchase is therefore not simply a question of whether the cash is available; where the shares bought in carry no such preference and shares carrying one are outstanding, the statute measures the purchase against the capital the board has fixed.

Who the Corporation Recognises as a Stockholder

A corporation's stockholder is the person its own records show, which is why the distinction between the holder of record and the person who beneficially owns the shares decides who votes. Delaware's corporation law defines the stock ledger as the records in which the names of all of the corporation's stockholders of record, the address and number of shares registered in the name of each, and all issuances and transfers of stock are recorded, and it provides that the stock ledger shall be the only evidence as to who are the stockholders entitled to examine the list of stockholders or to vote in person or by proxy at any meeting of stockholders. A person whose beneficial ownership of shares is complete but whose shares are registered in another name is therefore not the holder the corporation recognises when the votes are counted.

Some shares the records do show are nonetheless silent. Delaware's statute provides that shares of a corporation's capital stock shall neither be entitled to vote nor be counted for quorum purposes if they belong to the corporation, to another corporation a majority of whose shares entitled to vote in the election of directors is held directly or indirectly by the corporation, or to any other entity a majority of whose voting power is held directly or indirectly by the corporation or which the corporation otherwise controls directly or indirectly. A corporation cannot therefore recover the vote in its own stock by moving those shares to a subsidiary it controls, because the disqualification follows the control relationship rather than the name entered on the ledger. The same section preserves the right of a corporation to vote stock, including its own stock, that it holds in a fiduciary capacity.

Which holders of record are the relevant ones is settled by a record date, and that determination survives an adjournment unless the board acts. Under Delaware's corporation law a determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders applies to any adjournment of the meeting; the board of directors may fix a new record date for determining the stockholders entitled to vote at the adjourned meeting, and where it does so it must also fix, as the record date for the stockholders entitled to notice of the adjourned meeting, the same date or an earlier one. A meeting that is adjourned and later resumed therefore runs on the original determination by default, and moving it takes an affirmative act of the board.

The Short-Swing Profit Rule

The short-swing profit obligation the Securities Exchange Act places on officers, directors and ten percent stockholders runs to the issuer, and not to the government or to any counterparty. Any profit realised by such a beneficial owner, director or officer from any purchase and sale, or any sale and purchase, of an equity security of the issuer, other than an exempted security, within any period of less than six months inures to and is recoverable by the issuer. The period the provision fixes is one of less than six months, so a purchase and a sale separated by a longer interval than that are outside it however large the profit on the pair turns out to be. Suit to recover the profit may be brought by the issuer, or by the owner of any security of the issuer in the issuer's name and on its behalf if the issuer fails or refuses to bring the suit within sixty days after being asked to.

The recovery does not turn on proving anything about the insider's state of mind. The statute makes the profit recoverable irrespective of any intention on the part of the beneficial owner, director or officer, in entering into the transaction, of holding the security purchased or of not repurchasing the security sold for a period exceeding six months. The provision is framed as a measure for preventing the unfair use of information which may have been obtained by reason of the person's relationship to the issuer, but what the issuer has to establish in order to recover is the matched pair of transactions and the interval between them rather than the use of any information at all.

The provision's reach over a ten percent holder is tested at both ends of the matched pair. The statute is not to be construed to cover any transaction where the beneficial owner was not such both at the time of the purchase and sale, or of the sale and purchase, of the security involved. A person who was not a ten percent beneficial owner at the time of the first of the two transactions is therefore outside the provision for that pair, because the status has to exist at the time of the purchase and at the time of the sale alike.

The Proxy as an Instrument

A proxy has a statutory shelf life. Under Delaware's corporation law each stockholder entitled to vote at a meeting of stockholders, or to express consent or dissent to corporate action in writing without a meeting, may authorise another person or persons to act for that stockholder by proxy, but no such proxy shall be voted or acted upon after three years from its date unless the proxy provides for a longer period. The default is a limit rather than a standing authority, and extending it is a matter for the instrument itself and not for the corporation that receives it.

Revocability is the ordinary condition of a proxy, and irrevocability has to be established on two counts rather than one. The statute provides that a duly executed proxy shall be irrevocable if it states that it is irrevocable and if, and only as long as, it is coupled with an interest sufficient in law to support an irrevocable power, and it adds that a proxy may be made irrevocable regardless of whether the interest with which it is coupled is an interest in the stock itself or an interest in the corporation generally. A declaration of irrevocability on the face of the document is accordingly not enough on its own, and the irrevocability lasts only so long as the supporting interest does.

Where a certificate of incorporation departs from one vote a share, the departure carries through to every threshold the statute states as a proportion of shares. Delaware's corporation law entitles each stockholder to one vote for each share of capital stock held unless the certificate of incorporation provides otherwise, and provides that where the certificate gives more or less than one vote for any share on any matter, every reference in the statute to a majority or other proportion of stock, voting stock or shares refers to that majority or other proportion of the votes of such stock. Suppose a corporation has fifty million shares of a class carrying ten votes each and two hundred million shares of a class carrying one vote each: the voting power is 50,000,000 multiplied by 10, or five hundred million votes, plus two hundred million votes, or seven hundred million in all, and a majority of it is 350,000,001 votes. The high-vote class commands five hundred million of those votes on its own, so a class holding fifty million of the corporation's two hundred and fifty million shares — one fifth of them — carries any such threshold by itself.

Examination Relevance and Key Takeaways

Stock is tested on the SIE and Series 7 examinations in the context of corporate ownership structure, the rights of common and preferred shareholders, the capital structure hierarchy, Exchange Act Section 12 registration, and the primary and secondary market framework.

The key points to retain are these.

Stock is a security representing a fractional ownership interest in a corporation — the fundamental unit of equity capital. Limited liability — the principle that shareholders cannot lose more than their investment regardless of the corporation's obligations — is the foundational economic justification for the corporate and stock form of ownership.

Authorised shares are the maximum number the corporation may issue as specified in its articles of incorporation. Issued shares are those distributed to shareholders. Outstanding shares are issued shares minus treasury shares — used in all per-share calculations. Treasury shares are issued but not outstanding — held by the corporation itself, carrying no voting rights or dividends.

Common stockholders hold the residual ownership interest — they vote for directors and on major corporate matters, receive discretionary dividends when declared by the board, and receive whatever assets remain in liquidation after all creditors and preferred holders are satisfied.

Common equity is the junior-most claim in the capital structure — first to absorb losses and last to receive value — producing both the greatest risk and the greatest return potential of any security in the capital structure. Preferred stockholders have priority over common in both dividends — typically fixed in amount — and liquidation — typically at par value plus accrued dividends — but typically lack ordinary voting rights except upon dividend payment failure for a specified number of periods. 

Preferred stock is a hybrid security combining equity classification with debt-like economic characteristics of fixed dividends and priority claims.

The capital structure priority from highest to lowest claim is secured debt, senior unsecured debt, subordinated debt, preferred stock, and common stock. Exchange Act Section 12 requires stock registration when a company lists on a national securities exchange or when stock is held by more than two thousand holders of record with total assets above ten million dollars — triggering the full Exchange Act periodic reporting, proxy, insider reporting, and short-swing profit disgorgement framework.

Stock is valued using discounted cash flow analysis — through the Dividend Discount Model and its Gordon Growth Model variant — and relative valuation multiples including price-to-earnings and price-to-book ratios.