Equity represents ownership. Holders share residual cash flows after creditors, hold voting rights over corporate decisions, and bear residual risk if the firm fails. Within that umbrella, the basic features and types of equity instruments vary widely in cash flow priority, voting power, and liquidity.
Common shares are the baseline equity instrument. Holders have:
- Residual claim on assets and earnings after debt and preferred shares
- Voting rights, typically one vote per share, on directors and major corporate actions
- Variable dividends declared at board discretion, with no contractual right to payment
- Pre-emptive rights in some jurisdictions, allowing holders to maintain proportional ownership in new issues
The residual position cuts both ways. In a strong year common holders capture all upside after fixed claims. In bankruptcy they often recover nothing.
KEY: Common shares carry the highest expected return and the highest risk. Residual claim means last in line for cash flows and assets.
Many issuers create multiple classes of common shares with different voting rights. A typical dual-class structure:
Common mistakes
- Treating preferred as debt. Preferred dividends are not contractually owed. Missing one is not default. Bond interest is contractual, and missing it is default. Trap: calling skipped preferred dividends a "default event."
- Confusing cumulative and participating. Cumulative means missed dividends accrue. Participating means the holder shares in extra profits beyond the fixed rate. A preferred share can be one, both, or neither. Trap: assuming cumulative preferred shares in profits.
- Assuming all common shares vote equally. Dual-class structures give insiders disproportionate votes. Class A and Class B can have identical cash flow rights but vastly different voting power. Trap: computing voting control from share count without checking class structure.
Bottom line
- Common shares: residual claim, variable dividend, voting rights, and the highest risk and return of the equity stack.
- Preferred shares: fixed dividend, prior claim over common, usually non-voting.
- Cumulative preferred: missed dividends accrue and must clear arrears before any common dividend. Non-cumulative: missed dividends are forgone.
- Participating preferred: extra dividends or liquidation share beyond the fixed amount. Convertible: exchange for common at a set ratio.
Exam shortcut
For preferred features, remember CPCP: Cumulative (arrears accrue), Participating (extra upside), Convertible (exchange for common), Putable (holder can sell back). For voting, "Statutory = Seat-by-seat. Cumulative = Combined." For public vs private, the defining differences are liquidity and disclosure. Every other contrast (valuation, exit, investor base) flows from those two.
The full lesson (about 2,162 words, 14 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- equity instrument features
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