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Question

Difficulty: EasyEquity Securities and Characteristics

An investor holding common stock of a corporation receives a stock right giving them the opportunity to purchase shares of a newly announced stock issuance prior to the public offering. This privilege enables the investor to prevent the dilution of their current ownership percentage. Which equity characteristic or right does this scenario describe?

  1. Preemptive rightsAnswer
  2. B
    Cumulative voting rights
  3. C
    Liquidation preference
  4. D
    Dividend preference

Answer

Preemptive rights grant existing common stockholders the privilege to purchase newly issued shares before the public offering to maintain their proportional ownership percentage.
Preemptive rights give existing common stockholders the opportunity to subscribe to a new issue of stock in proportion to their current holdings before the shares are offered to the general public. This directly prevents dilution of ownership position and voting power.

Step-by-Step Solution

1
Identify the primary investor objective described in the scenario.
The investor wishes to maintain their existing percentage of corporate ownership when new shares are issued.
Issuing new shares to the general public increases the total outstanding share count, which dilutes existing shareholders' voting power and earnings per share unless they can purchase a proportional amount of the new issue.
2
Match the ownership protection feature to the correct equity right term.
Preemptive rights (also known as anti-dilution rights) give common shareholders first refusal on new corporate share issuances.
This is a fundamental statutory right associated with common stock ownership.

Key Concept

Preemptive Rights of Common Stockholders
Estimated Time:45s
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Topics

Equity Securities and Characteristics

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