Types of Equity Investments: A Comprehensive Guide | CFA Level I Equity Investments

In this lesson, we’ll discuss various types of equity investments, starting with an overview of equity securities.

Common Shares: Financing Company Operations

Companies finance operations by issuing debt or equity securities. While debt holders are contractually owed repayment plus interest, shareholders have a residual claim on company assets after liabilities are paid. These shareholders are considered company owners, holding common shares, ordinary shares, or common stock.

Callable and Putable Common Shares

Some common stocks come with embedded options, such as callable and putable features:

• Callable common shares allow the firm to repurchase the stock at a pre-specified call price.
• Putable common shares grant shareholders the right to sell shares back to the firm at a pre-specified put price.

Companies issue callable and putable shares to raise more capital or gain flexibility in repurchasing shares in the future at a fixed price.

Voting Rights and Systems: Empowering Shareholders

Common stockholders have the privilege of participating in important corporate decisions. They can exercise their voting rights to elect the board of directors, approve or reject proposed mergers, and select auditors for the company. The voting process is designed to empower shareholders and provide them with a voice in corporate governance.

Statutory Voting System

In a statutory voting system, each share held is assigned one vote in the election of each board member. For instance, if there are three seats to be filled, a shareholder with ten shares would have ten votes for each seat. This system, however, may lead to majority shareholders dominating the decision-making process, as they can allocate their votes to their preferred candidates and potentially decide the outcome of each election.

Cumulative Voting System

To provide better representation for shareholders with fewer shares, the cumulative voting system is often used. Under this system, shareholders can accumulate their votes and cast them for any candidate they wish. For example, if a shareholder has ten shares and three board seats are up for election, the shareholder would have 30 votes in total (10 votes per seat) and could choose to allocate all their votes to a single candidate or distribute them among multiple candidates. This system allows minority shareholders to have a stronger influence in the election process and prevents majority shareholders from dominating the decision-making.

In conclusion, voting rights and systems play a crucial role in ensuring fair representation for all shareholders in a company. By understanding the differences between statutory and cumulative voting systems, investors can better assess how their interests are represented within a company’s governance structure.

Preference Shares: A Unique Hybrid

Preference shares, or preferred stock, have features of both common stock and debt. They lack voting rights and typically make fixed periodic payments to investors but without a contractual obligation.

Non-Cumulative vs Cumulative Preference Shares

When companies struggle to pay preferred dividends:

• Non-cumulative preference shares don’t accumulate the shortfall.
• Cumulative preference shares accumulate any shortfall to be paid in the future.

Participating vs Non-Participating Preference Shares

Preference shares can be:

• Non-participating, with fixed dividends and equal claim to the par value during liquidation.
• Participating, receiving extra dividends if profits exceed a predetermined level and possibly a value greater than the par value during liquidation.

Convertible Preferred Shares: Limiting Risk and Sharing Profit

Convertible preferred shares allow preferred stockholders to exchange shares for common shares at a predetermined conversion ratio. These shares offer higher dividends, profit-sharing potential, increased value when common stock prices rise, and less risk compared to common shares.

Now that you’ve learned about various types of equity investments, we’ll distinguish between public and private equity securities in the next lesson.