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Question

Difficulty: EasyEquity Securities and Characteristics

An investor owning common stock of a publicly traded corporation wishes to protect their existing ownership percentage against dilution when the company issues new shares. Which of the following rights allows the investor to purchase a proportional number of the newly issued shares before they are offered to the general public?

  1. Preemptive rightAnswer
  2. B
    Cumulative voting right
  3. C
    Liquidation preference right
  4. D
    Preferred dividend preference right

Answer

The preemptive right allows existing common shareholders to purchase a proportional number of newly issued shares before they are offered to the public, preserving their ownership percentage.
Preemptive rights give existing common shareholders the privilege to purchase a proportion of newly issued shares before they are offered to the public, ensuring their voting power and percentage of ownership remain undiluted.

Step-by-Step Solution

1
Identify the investor's objective in the scenario.
The investor wants to maintain their exact proportional ownership percentage and prevent dilution when new shares are issued.
Issuing additional common shares increases the total share count, which dilutes existing shareholders' percentage ownership unless they purchase additional shares.
2
Match the goal to the appropriate common stock right.
The preemptive right directly addresses this anti-dilution requirement.
Preemptive rights grant current shareholders the first opportunity to buy newly issued equity shares in proportion to their current holdings.

Key Concept

Preemptive Rights of Common Stockholders
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Topics

Equity Securities and Characteristics

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