What Is an Equity Security? Definition, Types & Characteristics

Equity securities are a fundamental component of financial markets, representing ownership interests in companies. These instruments allow businesses to raise capital and provide investors with opportunities to participate in a company’s financial success. They are a significant part of many investment portfolios.

Defining Equity Securities

An equity security is a financial instrument that signifies an ownership share in a corporation. When an investor holds an equity security, they become a part-owner of the issuing company. This ownership grants the holder a claim on a proportion of the company’s assets and its earnings. For instance, if an investor owns 1% of a company’s total shares, they hold a 1% ownership piece of that company’s earnings and assets.

Equity securities differ from debt instruments, such as bonds, in their core nature. While debt instruments represent a loan made by an investor to a borrower, equity securities represent an ownership stake. Debt holders are lenders, expecting fixed payments and a return of principal, whereas equity holders are owners, whose returns are tied to the company’s performance and profitability. This distinction means equity investors assume more risk but also have greater potential for returns.

Key Characteristics of Equity Ownership

Equity ownership comes with distinct attributes and rights.
Shareholders often have voting rights, empowering them to influence corporate decisions. Common shareholders typically have the right to vote on significant company matters, such as electing the board of directors, approving mergers, or issuing new securities. While common shares often grant one vote per share, voting rights can vary, and some preferred stocks may even have limited or no voting rights.

Companies may distribute a portion of their earnings to shareholders as dividends. However, dividend payments are not guaranteed and are discretionary, depending on the company’s profitability and the board of directors’ decisions. Common stockholders typically receive dividends after preferred stockholders have been paid.

Equity holders have a residual claim on assets. In the event of a company’s liquidation or bankruptcy, equity holders have a claim on any remaining assets only after all creditors, bondholders, and preferred shareholders have been satisfied. This means common stockholders are typically last in line to receive any leftover value. This residual claim highlights the inherent risk in equity investments, as shareholders might receive nothing if the company’s assets are insufficient to cover its liabilities.

Types of Equity Securities

The most common forms of equity securities are common stock and preferred stock.
Common stock represents basic ownership in a company. Holders of common stock typically receive voting rights, allowing them to participate in corporate decisions. While common stockholders can receive dividends, these payments are not fixed and depend on the company’s financial performance. Common stockholders are generally last in line to receive assets in a liquidation, after creditors and preferred stockholders.

Preferred stock is another type of equity security that combines characteristics of both stocks and bonds. Preferred shareholders usually receive fixed dividend payments, which are paid out before any dividends are distributed to common stockholders. This preference makes preferred stock attractive to investors seeking stable income. Preferred stock also typically has a higher claim on a company’s assets than common stock in the event of liquidation. However, preferred stockholders generally do not have voting rights, distinguishing them from common shareholders.