101 Concepts for the Level I Exam
Concept 73: Types of Equity Securities
There are two types of equity securities: common shares and preference shares.
Common shares represent an ownership interest in a company, including voting rights. They entitle investors to a share of the company’s operating performance, participation in decision making in the form of voting rights and claim on the company’s net assets in case of liquidation.
- Common shareholders enjoy voting rights. In statutory voting, each share gets one vote. In Cumulative voting, each shareholder gets to cast one vote per share times the number of positions to be filled and shareholders can direct their total voting rights to specific candidates.
- Common shares may be callable or putable. Callable means that the issuer has the right to buy back shares from investors at a price by a specified date. Similarly, in the case of putable shares, investors have an option of selling the shares back to the company at a certain price.
Preference shares are preferred over common shares while claiming a company’s earnings in the form of dividends, and net assets upon liquidation. Preference shares can be cumulative, non-cumulative, participating or non-participating.
- Cumulative: Dividends accrue (add up) if the company does not pay dividends in one or more periods. When the dividend is paid in the subsequent years, the unpaid dividends accrue and are paid to preferred shares first before common shares.
- Non-cumulative: Dividends do not accumulate if a company decides not to pay dividends in one or more periods. However, whenever a dividend is paid, preferred shares get precedence over common shares. Because of this, a cumulative preferred share is worth more than a non-cumulative preferred share, all else equal.
- Participating: The right to receive the standard preferred dividend plus an additional dividend based on some condition like if the company’s profits exceed a certain level. In case of liquidation, participating shares are entitled to additional distribution of net assets.
- Non-participating: The right to receive only a fixed dividend. No share in the additional profits of a company.
Convertible preference shares are those which can be converted to common stock. The conversion ratio is specified when the shares are issued.