Types of Equity Securities

Types of Equity Securities

Equity securities give the holder an ownership claim on a corporation rather than a creditor's claim. That single distinction drives the structure of the entire equity universe: common shareholders bear residual risk and capture residual upside; preferred shareholders trade voting rights and upside for steady income and seniority over common; and a layer of related instruments (ADRs, rights, warrants) extends or modifies these claims in specific ways. The Series 66 tests the vocabulary, the legal positions, and a small set of mechanical features — voting structures, dividend types, conversion ratios, and the rights vs. warrants distinction.

Common stock and foreign equity exposure

Common stock represents an ownership interest in a corporation. Common shareholders have voting rights and a residual claim on assets and earnings after all creditors and preferred shareholders are paid. The basic distinction worth knowing before getting into mechanics:

• Domestic common stock — shares of U.S. corporations, traded on U.S. exchanges.
• Foreign common stock — shares of non-U.S. corporations, generally requiring access through a foreign broker or a U.S.-listed wrapper.
• American Depositary Receipts (ADRs) — certificates issued by U.S. depositary banks representing shares of foreign companies, traded on U.S. exchanges in U.S. dollars. ADRs are the standard wrapper U.S. retail investors use for foreign equity exposure; covered in detail in §4.

What common stock represents

Common stock is the standard form of corporate ownership. Each share carries three property-like attributes that together define what shareholders own:

The residual nature is the key to understanding why common stock is the highest-risk, highest-return-potential security a single corporation issues. Bondholders get paid first but cap out at their stated yield. Preferred shareholders sit in the middle. Common shareholders take all the downside and all the upside that's left over.

Authorized vs. issued vs. outstanding vs. treasury

Corporations don't simply have "shares of stock" — they have several distinct counts, each with a specific legal meaning. The Series 66 tests this vocabulary directly.

A worked example: Acme Corp's charter authorizes 100 million shares. Over its history it has issued 60 million. It has repurchased 5 million through buybacks, which now sit in treasury. Outstanding = 60M − 5M = 55M shares. EPS is calculated against the 55M, not the 60M issued. The 5M in treasury are economically dormant until the company either retires them (permanently reducing share count) or reissues them (typically for employee compensation).

Share classes and dual-class structures

Many U.S. corporations issue more than one class of common stock, typically labeled Class A and Class B (sometimes Class C and beyond). The economic claims may be identical or different; the voting rights almost always differ.

The most common pattern, popularized by tech IPOs:

• Class A — sold to the public via the IPO, typically one vote per share.
• Class B — held by founders and insiders, typically 10 votes per share (or sometimes even more). Often convertible to Class A on sale or death.

The result: founders can sell a majority of the economic ownership to outside investors while retaining voting control. Alphabet (Google) and Meta both use dual-class structures; Berkshire Hathaway's Class A (high price, single vote) and Class B (lower price, fractional vote) are a different historical variant.

The Series 66 tests recognition (different classes can have different voting rights despite equal economic claims) and the suitability implications (minority public shareholders may have very limited say in corporate governance even owning a majority of the economic equity).

Restricted stock and Rule 144

Not every share of common stock is freely tradable. Two categories require special handling under Rule 144 of the Securities Act of 1933:

• Restricted stock — shares acquired through unregistered private offerings (e.g., founder shares, private-placement purchases). The buyer agrees that the shares can't be resold to the public without registration or a Rule 144 exemption.
• Control stock — shares held by an affiliate of the issuer (officers, directors, 10%+ shareholders). The stock itself may be freely tradable, but the affiliate's status triggers the same resale restrictions.

Rule 144 provides a path to public resale without full SEC registration, subject to four conditions:

• Holding period. Six months for reporting (SEC-filing) companies; one year for non-reporting companies. The clock starts on the date the buyer paid for the shares.
• Current public information. Adequate current information about the issuer must be publicly available (typically satisfied by current SEC filings).
• Volume limitations (for affiliates only). Sales in any 3-month period limited to the greater of 1% of outstanding shares or the average weekly trading volume of the previous 4 weeks.
• Notice filing (Form 144) when proposed sale exceeds 5,000 shares or $50,000 in value within a 3-month period.

Non-affiliates holding restricted stock can sell freely after the holding period expires, with no volume limit. Affiliates are always subject to the volume restrictions, even after the holding period.

Statutory vs. cumulative voting

When shareholders vote on a slate of directors, two voting structures are common. The structure determines whether minority shareholders can ever elect any directors of their choosing.

The threshold formula. Under cumulative voting, the minimum shares needed to guarantee electing n directors out of N being elected, given S total shares voting, is:

For 100,000 shares voting and 5 director seats: guaranteeing 1 seat requires floor(100,000 ÷ 6) + 1 = 16,666 + 1 = 16,667 shares. Guaranteeing 2 seats requires 33,334. The interactive below lets you test variations.

Pre-emptive rights and proxy voting

Pre-emptive rights protect existing shareholders against dilution when the corporation issues new shares. If a shareholder owns 10% of a company and the company issues new stock, the shareholder has the right to buy enough of the new issue to maintain that 10% stake. Without pre-emptive rights, a new issue dilutes existing shareholders' ownership percentage and voting power.

Pre-emptive rights are not automatic in every state. Many state corporate codes set "opt-in" rather than "opt-out" defaults — the corporate charter has to explicitly grant them. When granted, they are typically exercised through a rights offering: existing shareholders receive transferable rights to buy new shares at a fixed price (usually below the market price) within a short window.

Proxy voting handles the reality that most shareholders don't attend annual meetings. A proxy is a written authorization for someone else (typically management, an institution, or a proxy-advisory service) to vote a shareholder's shares according to the shareholder's instructions or the proxy holder's discretion. Proxy materials must be filed with the SEC and provide detailed information about each item to be voted on.

Common proxy votes include: election of directors, approval of auditors, approval of executive compensation ("say on pay"), shareholder proposals on environmental and social issues, and major corporate actions (mergers, charter amendments).

Preferred stock — the basics

Preferred stock is a hybrid security with characteristics of both equity and debt:

• Fixed dividend (like a bond coupon), but dividends are not legally guaranteed — the board must declare them.
• Priority over common stock for dividends and liquidation distributions.
• Generally no voting rights, except contingent rights that activate if dividends go unpaid.

The hybrid nature means preferred trades partly like a bond (interest-rate sensitive, principal-stable when rates are stable) and partly like a stock (subordinated to bondholders, eligible for qualified dividend tax treatment). Section 3.3 covers the major preferred variants in detail.

Preferred stock — the hybrid security

Preferred stock sits between bonds and common stock in the capital structure. From an investor's perspective, three differences from common matter most:

• Fixed dividend rate. Preferred dividends are stated as a fixed percentage of par (typically $25 or $100 par). A 6% preferred on $25 par pays $1.50 per share annually, period. The income looks like a bond coupon — but unlike a coupon, it isn't legally guaranteed.
• Priority over common. If the company can pay any dividends, preferred gets paid before common. In liquidation, preferred is paid before common (but after all creditors and bondholders).
• Generally no voting rights. Preferred shareholders trade voting power for dividend priority and steadier income. They do typically gain voting rights if dividends go unpaid for a specified number of quarters — a fallback that protects the dividend priority.

The four features the Series 66 tests on preferred:

• Cumulative vs. non-cumulative. Whether missed dividends accumulate as arrears. Most preferred is cumulative; non-cumulative is much riskier for the holder and trades at a discount to comparable cumulative issues.
• Callable. Whether the issuer can redeem the preferred at a stated price. Like callable bonds, this caps the upside and creates reinvestment risk.
• Convertible. Whether the preferred can be exchanged for common shares at a stated ratio.
• Participating. Whether the preferred receives anything beyond the stated rate when company performance is strong.

Preferred stock types at a glance

Preferred stock vs. bonds vs. common stock

Preferred sits between bonds and common on every dimension that matters to the Series 66:

The tax-treatment row matters most for after-tax suitability. Preferred dividends are usually "qualified" and taxed at favorable long-term capital gains rates (0%, 15%, or 20%), while bond coupons are taxed at ordinary income rates. For high-bracket investors comparing a 5% preferred yield against a 5% corporate bond yield, the preferred typically wins after tax — until you account for the bond's seniority advantage.

ADRs — what they are and how they work

American Depositary Receipts (ADRs) are the primary way U.S. investors access foreign equity. The mechanics are straightforward: a U.S. depositary bank (BNY Mellon, JPMorgan, Citi) buys foreign shares on the foreign exchange and issues U.S. certificates representing those shares. The certificates trade on U.S. exchanges in U.S. dollars and pay dividends in U.S. dollars (converted from the foreign currency by the depositary bank).

One ADR typically represents some integer or fractional number of underlying foreign shares; the ratio is set by the depositary bank to land the ADR price in a range U.S. investors find liquid. From the U.S. investor's perspective the ADR behaves like a U.S. stock with one crucial added wrinkle — currency risk on the underlying shares, covered in detail later in this section.

ADR Levels — what each tier means

American Depositary Receipts come in three sponsored "Levels" and one unsponsored variant. Each level represents a different commitment by the foreign issuer to U.S. disclosure and listing standards.

Currency risk — the ADR's hidden variable

Even though ADRs trade in U.S. dollars on U.S. exchanges, the underlying shares are valued in the foreign company's local currency. Every dollar price you see is implicitly an exchange-rate translation of the foreign share price. Two consequences:

• Foreign currency strengthens against USD → ADR price rises (foreign shares are worth more dollars per unit).
• Foreign currency weakens against USD → ADR price falls (foreign shares translate into fewer dollars).

Worked example. A Japanese company's stock trades at ¥10,000 per share. The ADR represents 1 share, and the exchange rate is ¥100 = $1. The ADR price is roughly $100. Three months later, the stock is still at ¥10,000 per share — no change in the local-currency price. But the yen has weakened to ¥110 = $1. The ADR price drops to roughly $10,000 ÷ 110 = $90.91 — a 9% decline driven entirely by the currency move, with the underlying business unchanged.

The reverse can amplify gains: if the yen strengthens to ¥90 = $1, the same ¥10,000 stock becomes $111.11, a 11% gain from currency alone. ADRs effectively hold two positions stacked on each other — the foreign stock and a long position in the foreign currency. Both have to move in the right direction for the U.S. investor to gain.

GDRs and direct foreign investment

ADRs are U.S.-specific. Global Depositary Receipts (GDRs) are the broader, multi-jurisdiction equivalent — depositary receipts that can be listed and traded on multiple foreign exchanges simultaneously (commonly Luxembourg and London, with parallel availability to U.S. institutional investors via Rule 144A or Regulation S exemptions).

From a Series 66 perspective, the key distinctions:

• ADRs: single market (United States); trade on U.S. exchanges in U.S. dollars; held by U.S. retail and institutional investors alike.
• GDRs: multiple foreign markets simultaneously; held mostly by institutional investors; often used by emerging-market issuers (Indian, Russian, Chinese) to access global capital without a full U.S. listing.

Two additional ways U.S. investors access foreign equity, worth knowing for completeness:

• Direct foreign investment. Buy shares on the foreign exchange directly through a broker with international access. Requires foreign currency conversion and exposure to local regulations; available mostly to institutional and sophisticated retail investors.
• International mutual funds and ETFs. The default vehicle for retail foreign exposure. Diversified, no individual ADR analysis required, currency-hedged or unhedged versions available. Discussed in the pooled-investments chapter.

Rights — the pre-emptive offering mechanism

A right (or "subscription right") is a short-term security that gives existing shareholders the option to buy newly-issued shares of common stock at a stated price below the current market price. Rights are how corporations implement pre-emptive rights when they issue new shares.

Key mechanical features:

• Short-lived. Typical exercise windows are 30 to 45 days from the date of issuance. After that, unexercised rights expire worthless.
• Issued to existing shareholders pro rata. A shareholder who holds 1% of outstanding common gets 1% of the rights, preserving their proportional ownership.
• Exercise price below market. Rights are designed to be "in the money" at issuance — if the market price is $50, the right might let you buy a new share at $45. This makes rights immediately valuable rather than speculative.
• Transferable. Shareholders who don't want to exercise can sell their rights in the secondary market. Whoever holds the right at exercise can buy the new shares.

The economic value of a right depends on the spread between the market price and the exercise (subscription) price, minus a small adjustment for the time premium. In a healthy market the spread holds; in a falling market the right can lose value faster than the underlying stock.

Warrants — long-dated equity options

A warrant is a long-term security that gives the holder the right to buy a specified number of shares of the issuer's common stock at a fixed exercise price, at any time before the warrant's expiration. Warrants resemble rights mechanically but differ in three significant ways:

• Long-dated. Warrants typically run 5 to 10 years before expiration; some are issued in perpetuity. Compare to rights' 30-45 day window.
• Exercise price above market at issuance. Warrants are typically issued with an exercise price above the current market price — the warrant is "out of the money" at issuance and depends on stock appreciation to gain value. Compare to rights, which are in-the-money at issuance.
• Often attached to bonds or preferred. Warrants are commonly issued as a "sweetener" attached to a corporate bond or preferred-stock offering to lower the coupon or dividend the issuer has to pay. Warrants can be "detachable" (sold separately after issuance) or "non-detachable."

Because warrants give the holder long-term call-option exposure to the company's stock, they are valued similarly to call options — the further out the expiration, the more out-of-the-money they can be while still having meaningful value. Warrants are common in growth-company financing and especially common in SPAC structures.

Rights vs. warrants — side by side