Shareholder rights and warrants

The textbook says that these are the seven basic rights of a shareholder:

  1. Right to a share of dividends.
  2. Right to vote for the Board of Directors.
  3. Right to inspect books and records.
  4. Right to maintain proportionate ownership.
  5. Right to vote for stock splits.
  6. Right to assets upon the dissolution of the business.
  7. Right to transfer ownership.

But also says that, because the issuance of warrants is a dilutive action, it must be approved by stockholders. I’m guessing that #4 is actually more general than written, but I could also see that applying to #5

What am I missing?

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Hi @Trent!

Great question! Warrants would fit best in the ‘right to maintain proportionate ownership’ category, but we need to go over the details. Try to disregard the exact title of the right for this question; in a perfect world, it would be titled “Right to approve or disapprove dilutive actions, or to maintain proportionate ownership during a dilutive action.” Obviously we keep titles short for aesthetic purposes, but it can sometimes lead to questions like yours.

The issuance of warrants is a dilutive action. Plain and simple, if a small group of investors obtains newly issued shares, and those shares are not available to all current stockholders, it’s a dilutive action. We see this most often with issuance of convertible securities, but it also occurs with warrants. Before issuing new shares (or the right to buy new shares, like a warrant) to the public, the issuer must do one of two things:

  • Offer first rights to those new shares to all current stockholders (rights offering)
  • Gain approval from current stockholders to do the dilutive action

Warrants fall into the second bullet point above, similar to issuance of convertible securities. Warrants will be issued to a new set of investors and are not offered to all current stockholders first. As you probably read in the material, warrants are typically issued as sweeteners with another security, like a bond. Issuing warrants helps the issuer make the bond (or whatever security they’re attaching the warrants to) more marketable, potentially allowing the bond to have a lower interest rate, therefore saving the issuer money. The more money the issuer saves, the more profitable it is, and the better off its investors are.

In the end, current stockholders may not be given warrants when they’re issued, but their issuance could make the company they’re invested in more profitable, leading to higher stock prices. For this reason, stockholders commonly approve warrants to be issued.

I hope this helps! Please respond if you have any questions.

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Welcome @Trent, and thanks for the great explanation, @brandonrith.

Just wanted to add a quick link to the relevant chapter - https://app.achievable.me/study/finra-sie/learn/common-stock-rights-of-common-stockholders-right-to-maintain-proportionate-ownership

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Thanks for the help guys, that clears things right up!

For me thinking of an example helps…(made up- though they did issue new bonds during Covid )

Take Disney due to Covid - their stock price dropped… Expected income due to park closures - hotel- cruises- and movies…evaporated.
Disney still needed income and decided to issue callable bonds…
After not getting the response needed to refill coffers in Scrooge McDuck’s Vault
but unwilling to remove the callable feature-
Disney decides to add a warrant to sweeten (like a spoonful of sugar to make the medicine go down) to the bond.
Disney goes to current stockholders asking for a vote to allow Disney to keep Walt’s Dream alive by adding warrants to the bonds…
Given either not having Disney funded and seeing their stock prices drop further or having the stocks they own be a smaller piece of the Disney Pie-
The vote comes back a Yes (as Disney Stockholders - believe in time that Disney will recover)
And so the magic of Disney dreams continues

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Thanks for the example!

Related but a little bit off topic: it is really interesting to see how everyone is adjusting their financial practices to make it through COVID.

I have a small investment in a piece of commercial real estate. A few months ago prior to any COVID news, the management company was aggressively negotiating, doing tenant fit-outs, etc., and promising investors that they’re operating in a way to maintain income and dividend payments regardless of overall market conditions. Then COVID hits, and the anchor tenant told the management company that they just weren’t going to pay rent for the next few months. Needless to say the management co and investors aren’t too happy to eat the substantial cost of that missing rent and to have all returns disappear for the near feature. But forcing the tenant to pay would likely put them out of business, which would be an even worse outcome for everyone… so we’re all content to just let it slide.

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I live in Jacksonville Fl- during Covid I read we were among the 10 worst in pension liabilities…This made me expect that the city would be one of the 1st to reopen in an effort to get more money for the city’s debts…
If you remember Jax Beach Fl trended as Jax opened the beaches really before anyone else was doing so…Shortly afterwards the city started reopening even though Drs viewing Covid numbers did not support this…
Maybe I was reading into things due to studying muni bonds at same time -
Thoughts

I really love the COVID example, @Test! The current landscape in 2020 creates challenges for companies (like Disney) to raise capital (money). Disney’s parks being shut down until mid-July (and possibly shut down further due to a growing second wave) is a huge revenue loss for the company. Thankfully for their investors, Disney is much bigger than its parks and has numerous revenue sources that don’t depend on packing customers into enclosed spaces.

A similar company with less revenue sources may be financially distressed, especially if their entire business model is tied to physical spaces (like cruise lines, restaurants, and other amusement parks). To keep themselves afloat, they could attempt to sell a bond and borrow money from investors. The interest rate would be high due to the risk involved, but gaining shareholder approval to attach a warrant to the offering would smooth things out a bit. Maybe the warrant allows the issuer to reduce the interest rate (coupon), maybe it makes the bond more marketable, maybe it does both.

Regardless, shareholders are likely to approve the warrant offering, although it would dilute their shares. What would be worse? Approving the warrants and getting shares with less voting and earnings (dilution), or preventing the company from obtaining reasonable financing and watching their cost of business go up (possibly threatening bankruptcy)? Neither situation is ideal, but I know what I would prefer if I were a shareholder.

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