Common stock: ownership, limited liability, order of liquidation and voting rights
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Ownership and limited liability
Common stock represents an ownership interest in a corporation. Stock is an equity security under 17 C.F.R. § 240.3a11-1. A stockholder is an owner, while a bondholder is a creditor. Common shares have no contractual maturity date or promised repayment of principal. Dividends depend on a declaration by the board of directors; profits do not create an automatic dividend obligation.
Limited liability means a holder of fully paid common shares is not personally responsible for corporate debts merely because of share ownership. The investor can lose the entire amount invested. Limited liability protects against responsibility for the corporation's debts; it does not protect the stock's market value.
Last in liquidation
Common stockholders have a residual claim. Creditors are paid before equity holders, and preferred stockholders have priority over common stockholders. Common receives whatever remains after those senior claims are satisfied, which may be nothing. A large voting interest does not improve liquidation priority.
Voting rights
Common stockholders generally elect directors and vote on certain major corporate changes, such as mergers. They do not run daily operations or declare dividends themselves. A proxy authorizes another person to vote a stockholder's shares. Actual voting rights depend on the share class and corporate governing documents; some common shares have reduced or no voting rights.
For ordinary voting shares with one vote per share, distinguish two director-election methods. Statutory voting, also called straight voting, permits one vote per share for each seat being filled. A holder of 100 shares electing three directors may cast up to 100 votes for each seat, but cannot concentrate 300 votes on a single candidate.
Cumulative voting provides shares multiplied by director seats as a pool of votes that can be concentrated or divided among candidates. With 100 shares and three seats, the pool is 300 votes. All 300 may go to one candidate. This can help minority shareholders obtain board representation, but does not guarantee election.
Keep the three concepts separate: limited liability concerns corporate debts, liquidation priority concerns distributions when the corporation winds up, and voting concerns corporate governance.
Sample questions
Which description identifies the relationship created by owning common stock?
Reveal answer
Correct answer: An ownership interest in the issuer
Common stock represents ownership. Lending, scheduled principal repayment, and collateral claims describe debt features rather than common equity.
An investor pays $4,000 in cash for fully paid common shares. The issuer later fails with unpaid corporate debts. What does limited liability mean for this investor solely as a shareholder?
Reveal answer
Correct answer: The investor may lose $4,000 but is not personally responsible for the corporate debts.
Limited liability separates corporate debts from the personal obligations of a holder of fully paid shares. The entire $4,000 investment remains at risk.
Which group has the residual claim on assets when a corporation liquidates?
Reveal answer
Correct answer: Common stockholders
The residual claim belongs to common stockholders: they receive what remains after creditors and preferred stockholders are satisfied.