Ch4. Stock & Capital — Share Classes, Capitalization & Dividends

Shares of Stock — Overview and Classes

Share of Stock:
The unit into which a corporation's equity is divided.
Represents a proportional ownership interest in the corporation.

Share classes:
┌────────────────┬──────────────────────────────────────────────┐
│ Common Stock   │ Basic bundle of rights: voting + dividends   │
├────────────────┼──────────────────────────────────────────────┤
│ Preferred Stock│ Priority in dividends & liquidation proceeds │
│                │ Often non-voting or limited voting            │
│                │ Cumulative vs. non-cumulative                 │
├────────────────┼──────────────────────────────────────────────┤
│ Junior / Sub.  │ Subordinated to common in distribution        │
├────────────────┼──────────────────────────────────────────────┤
│ Hybrid Stock   │ Blended preferred + subordinated features     │
└────────────────┴──────────────────────────────────────────────┘

Registered vs. Bearer shares:
Modern US corporations issue registered shares only.
Bearer shares are prohibited (FinCEN / AML rules).

Treasury Stock

Treasury Stock:
Shares that the corporation has issued and subsequently
repurchased (bought back) from shareholders.

Buyback requirements:
- Must comply with state-law solvency tests
  (e.g., Delaware: surplus test or net-assets test)
- Board approval required; large programs often
  disclosed to shareholders and the SEC

Effects of treasury stock:
No voting rights (treasury shares cannot vote)
No dividends paid on treasury shares
May be retired (cancelled) or re-issued

Buyback restrictions:
Must pass insolvency tests; SEC Rule 10b-18 governs
the manner of open-market repurchases.

Raising and Reducing Capital

Capital Increase (Equity Financing):
Cash issuance: new shares sold for cash → equity & assets both increase
Stock dividend / bonus issue: retained earnings → stated capital
  → equity increases, but total assets unchanged

Pre-emptive Rights:
Existing shareholders may have a statutory or charter right
to purchase new shares pro rata before outsiders.
Charter or board may waive pre-emptive rights.
Third-party directed issuance permitted with proper board
or shareholder approval.

Capital Reduction (Share Repurchase or Par-Value Reduction):
Cash repurchase: assets and equity both decrease
Par-value reduction to eliminate deficit: stated capital decreases;
  assets unchanged (accounting adjustment only)

Capital reduction procedure:
Board resolution + shareholder approval (often supermajority)
+ creditor-protection notice period

Dividends

Cash Dividend:
The corporation distributes cash to shareholders of record
on the record date.

Declaration process:
Board of directors declares the dividend (MBCA / state law)
Charter may permit board to declare dividends without
shareholder vote.

Cash vs. Stock Dividends:
Cash dividend: cash paid out to shareholders
Stock dividend: new shares issued; retained earnings →
  stated capital (shareholder's pro-rata interest unchanged)

Dividend limitation:
Dividends may be paid only out of legally available funds:
= Surplus (net assets minus stated capital) [Delaware surplus test]
  OR
= Net profits of the current or preceding fiscal year [MBCA earned-surplus test]

Interim / Special Dividends:
Permitted if the board declares them and surplus is available;
no limit on frequency under most state laws.

Stock Dividend vs. Cash Issuance ★★★★★ : Cash issuance = new shares sold for cash → both equity and assets increase. Stock dividend = retained earnings reclassified as stated capital → equity changes but total assets do not. Memory hook: cash issuance = real money in; stock dividend = accounting reclassification

Treasury Stock Has No Rights ★★★★★ : Treasury shares carry no voting rights and receive no dividends. They may be retired or re-issued. Memory hook: treasury stock = dormant shares

Dividend Limitation — Surplus Test ★★★★☆ : Dividends are limited to legally available surplus. Paying dividends while insolvent or in excess of surplus exposes directors to liability. Memory hook: dividends = surplus only, not capital

Practice Questions

Q. Why do preferred shareholders sometimes lack voting rights?

Preferred stock is designed for investors who prioritize economic returns (preferred dividends and liquidation priority) over governance participation. In exchange for that economic preference, preferred shareholders typically receive no vote or a limited vote. Non-voting preferred stock issuances are explicitly permitted under most state corporation statutes.

Q. How does a stock dividend differ from a cash issuance from the shareholder’s perspective?

In a cash issuance, the shareholder pays cash and receives new shares, preserving their proportional ownership. In a stock dividend, the shareholder receives new shares for free, but the share price adjusts downward proportionally, leaving the real economic value of their holding unchanged. The difference is that with a cash issuance the company receives new capital, whereas a stock dividend is merely an internal accounting transfer.