1.1 Common Stock Basics

What Is Common Stock?

Common stock is a security representing proportional ownership in a corporation. Buyers become shareholders with a claim on the firm's residual assets and earnings. On the Series 7 exam (125 scored questions, 225 minutes, 72% to pass, administered by FINRA at Prometric centers), equity securities are a high-frequency topic, so master these fundamentals first.

Unlike bondholders, who are creditors, common stockholders are equity owners. This distinction drives liquidation priority: in a corporate dissolution, holders are paid in a strict order. The exam tests this sequence constantly.

Liquidation Priority (Memorize the Order)

1. Secured creditors (e.g., mortgage bondholders)
2. Unsecured creditors (debentures, general creditors, wages, taxes)
3. Subordinated debenture holders
4. Preferred stockholders
5. Common stockholders (last)

This residual claim is why common stock carries the highest risk and the greatest growth potential of the three core securities.

Shareholder Rights

Note that common holders do not vote on the dollar amount of a cash dividend, and they cannot compel the board to declare one.

Voting Methods

Shareholders generally receive one vote per share per board seat. Two methods appear on the exam:

Statutory voting allots one vote per share per seat, applied separately to each seat. With 100 shares and three open directorships, you may cast up to 100 votes for each of the three candidates, but no more than 100 for any one. Statutory voting favors large/majority holders.

Cumulative voting lets you aggregate votes and pile them onto fewer candidates: total votes = shares × seats. With 100 shares and three seats you control 300 votes that can all go to one nominee. Cumulative voting favors minority shareholders because it improves their odds of seating a representative.

$\text{Total Cumulative Votes} = \text{Shares Owned} \times \text{Seats Open}$

Proxy voting lets absent shareholders authorize someone to vote their shares. Public companies must solicit proxies before annual meetings under SEC rules; a proxy is essentially an absentee ballot, not a transfer of ownership.

Share Classifications

$\text{Outstanding} = \text{Issued} - \text{Treasury}$

Firms buy back stock to boost earnings per share, fund employee stock plans, support the price, or deter takeovers. Treasury stock is not used in EPS calculations and carries neither vote nor dividend.

Par Value vs. Market Value

Par value for common stock is an arbitrary bookkeeping figure (often $0.01 or $1) with no relation to worth; it matters mainly for the corporation's balance sheet. Market value is the live trading price set by supply and demand and is what your clients actually pay or receive.

Limited Liability — A Common Trap

Under limited liability, a shareholder's maximum loss equals the amount invested; personal assets are shielded from corporate debts. Contrast this with a general partnership, where partners bear unlimited personal liability. The exam often pairs this concept with the residual claim to test whether you understand that "last in line" does not mean "liable for more." Even if the corporation goes bankrupt owing far more than its assets, a shareholder who paid $5,000 for stock can lose no more than that $5,000.

Classes of Common Stock

Many companies issue more than one class of common stock to separate economic ownership from voting control. A typical arrangement gives founders Class A super-voting shares (e.g., 10 votes each) while public investors buy Class B shares with one vote each. Both classes usually share equally in dividends. The exam wants you to recognize that voting power and dividend rights can be split across classes, and that a class with reduced or no votes still has the residual claim and dividend participation.

Statement of Ownership and Transfer

Most shares today are held in book-entry form (electronic) rather than as paper certificates. Ownership is recorded by the transfer agent, which cancels old certificates and issues new ones, and the registrar, which audits that the number of shares outstanding never exceeds the authorized amount. Stock is freely transferable, which is one reason it is more liquid than a partnership interest. When you advise a client to sell, settlement and re-registration flow through these agents.

Common Stock Risks and Rewards

The exam frames suitability around this trade-off: common stock suits investors seeking growth who can tolerate volatility and the residual-claim risk, not those needing guaranteed income or principal protection.

Exam Focus

• The exact liquidation order (common is always last).
• Statutory vs. cumulative voting, and which protects minority holders.
• Outstanding = issued − treasury (treasury shares neither vote nor receive dividends).
• Dividends are discretionary; there is no guaranteed return on common stock.