COMM 309 — Business Finance
CHAPTER 19: Equity and Hybrid
Instruments
Comprehensive Exam Preparation Notes
19.1 Shareholders' Equity
Equity securities represent ownership interests in a corporation. Common shares are certificates of this
ownership — common shareholders are the true "owners" of the corporation. Preferred shares provide owners
with a preferential claim to a fixed amount of equity or dividends established at issuance. Importantly, the terms
"common share" and "preferred share" have no statutory definition in Canada under the Canada Business
Corporations Act (CBCA); they describe only different classes of securities within shareholders' equity.
Unlike debt, equity cannot have a fixed contractual commitment — it receives whatever remains after all fixed
commitments are paid. Equity holders are the "residual" claimants on the firm's assets and income.
Consequently, dividends paid on equity are not tax deductible, whereas interest on debt is.
The CBCA 24(3) specifies that, where a corporation has only one class of shares, holders have three fundamental
rights:
• (a) The right to vote at any meeting of shareholders;
• (b) The right to receive any dividend declared by the corporation;
• (c) The right to receive the remaining property of the corporation on dissolution.
Shareholder Rights
The Right to Vote
The most fundamental right of common shareholders is the right to vote. At the annual general meeting (AGM),
shareholders vote on:
• Election of the Board of Directors (BOD), who determine corporate strategy and appoint senior
management;
• Appointment of the firm's auditors;
• Changes to the articles of incorporation and bylaws;
• Major changes in firm operations, such as acquisitions via share exchange or disposition of major assets.
As corporations have grown larger, the "distance" between the firm and its owners has increased, making it
harder for shareholders to enforce rights. Ensuring shareholders can exercise these rights is referred to as
corporate governance.
The Pre-Emptive Right
The pre-emptive right is the right of existing shareholders to maintain their proportional ownership when new
shares are issued. For example, if a firm issues 50% more shares and grants a pre-emptive right, existing
shareholders may buy 50% more shares to maintain their proportional stake. Without this right, the company can
sell shares to new shareholders, diluting existing ownership.
Historically, most new share issues in Canada were made through "rights offerings" to existing shareholders.
Starting in the 1950s, Canadian companies removed the pre-emptive right to sell shares more quickly and
cheaply to institutional investors. Today, very few rights offerings are made in Canada. Firms can issue an
unlimited number of authorized common shares without needing shareholder approval, further concentrating
power in senior management.
📌 AIG Example — Reverse Stock Split and Dilution
COMM 309 — Chapter 19: Equity and Hybrid Instruments | Page 1
, During the 2008–09 financial crisis, the U.S. Federal Reserve needed to take an 80% interest in AIG to
prevent collapse. Because the authorized share count was insufficient, a 1-for-20 reverse stock split was
executed: every 20 existing shares were exchanged for 1 new share, freeing up authorized shares for the
Fed to purchase. AIG's largest shareholder, former CEO Maurice "Hank" Greenberg, saw his ownership
dramatically diluted and sued the U.S. government. The Supreme Court found the actions legal (though the
Fed technically violated rules by buying common shares), recognizing the necessity of saving the financial
system.
Other Rights — Dividends, Dissolution, and Limited Liability
Equity holders are residual owners — they receive dividends and remaining assets only after all other
claimants are paid. Key points:
• No right to a dividend until the BOD declares one. Shareholders cannot legally force dividend payment.
The firm must have resources to pay the dividend without impairing its ability to meet fixed commitments.
• On liquidation, all other claimants on the firm's assets must be paid before equity holders receive anything.
• Limited liability: Equity holders commit initial capital by purchasing shares but are legally protected from
being forced to invest more, even if the firm cannot meet its fixed commitments. Shareholders can only lose
their initial investment — their downside risk is limited, while upside potential is unlimited. This
asymmetry gives common shares characteristics similar to call options.
Different Classes of Shares
The CBCA qualifies the three fundamental shareholder rights by stating they apply "where a corporation has only
one class of shares." When multiple classes exist, the firm must specify in its articles of incorporation how the
three rights are distributed. The only legal requirement is that each of the three rights must be attached to at least
one class of shares.
A typical Canadian share structure example:
📌 Example Share Structure (CBCA Compliant)
Class A Shares (Non-Voting / Limited Voting Shares):
• No voting rights as long as dividends are being paid
• $0.05 extra dividend above Class B, but only if Class C dividends are not in arrears
• Equal share with Class B in residual receipts on winding up
Class B Shares (Common Shares):
• Full voting rights
• No dividends if Class C dividends are in arrears
• Equal share with Class A in residual receipts on winding up
Class C Shares (Preferred Shares):
• No voting rights unless dividends are in arrears for two years, then each share gets one vote
• Fixed dividend of $0.30/share per quarter when declared by BOD; no dividends on Class A or B if Class
C in arrears
• Receives $25 par value before any payments to Class A or B on winding up
Voting and Non-Voting Shares
Voting rights give shareholders control over the BOD and management direction. In takeover situations, voting
shares are more valuable than non-voting shares because an acquirer must buy the voting shares to gain
control — this is called the "control value."
Example — CHUM Ltd. (2006): Bell Globemedia offered $52.50 for Class A (voting) shares and $47.50 for Class
B (non-voting) shares, a $5 premium for control. To prevent similar discrimination for new listings, the TSX
introduced "coattail" provisions requiring all classes of shares to be purchased in a takeover (non-voting shares
"ride the coattails" of voting shares). Companies already listed were grandfathered.
The pattern is common in family-run businesses: founders need external capital but want to maintain control via
multiple voting shares. Example — Four Seasons Hotels (Isadore Sharpe family, 67% of votes through multiple
COMM 309 — Chapter 19: Equity and Hybrid Instruments | Page 2
, voting shares). Problems arise when the founding generation's talent is not inherited — CHUM Ltd. is a classic
example where control passing from the founder led to strategic drift and eventual hostile takeover.
Family Trusts
A family trust is a mechanism that ensures income flows to descendants of the company founder while all votes
are held by the trustees. This separates ownership from control across generations. Example — Ford Motor
Company: 71 million Class B shares (40% of votes) are held in a family trust. All descendants receive income, but
voting control stays with the trustees, even though the Ford family owns only ~2% of the total company equity.
The downside: when family members installed Clay Ford (great-grandson of Henry Ford) as CEO in 2001, Ford's
stock price dropped from ~$20 to under $2 by 2008. Alan Mullaly was eventually brought in as CEO and pledged
Ford's assets to raise capital just before the 2008 crisis, avoiding bankruptcy. Ford's share price recovered to
~$15, though shareholder resolutions to change the share structure continue to receive increasing support.
📌 Key Insight — Dual-Class Shares Trend
The number of dual-class share firms on the TSX has declined significantly — from 168 firms in 1993 to
only 83 by 2009. As the Canadian economy matured, the dominance of family-run businesses with founder
control has decreased. However, the issue remains controversial — at Magna International, Frank
Stronach received an $860-million buyout of his multiple-voting shares — a premium of ~1,800% over the
value of regular shares — sparking an OSC investigation into the fairness of dual-class structures.
Calculating Share Value and Dividend Yield
Using Canadian Pacific (CP) as an example. As of December 31, 2014, CP had 166.1 million shares outstanding
with total common equity of $5,610 million. Key calculations:
Book Value Per Share (BVPS)
BVPS = Common Equity / BVPS indicates the amount of money shareholders have
Number of Shares invested in the firm, either directly or through retained earnings.
CP 2014: BVPS = $5,610M ÷ 166.1M = $33.77
BVPS = $5,610M / 166.1M = $33.77
Market price (P) = $223.75 → reflects current and future
expected profitability.
Market-to-Book Ratio (M/B)
M/B = Price / BVPS A high M/B ratio (>1) indicates the market values the firm well
above its book equity — typical of a growth company.
M/B = $223.75 / $33.77 = 6.63
CP 2014 M/B = 6.63 → regarded as a growth company.
Dividend Yield
Dividend Yield = Dividend per CP 2014: Paid $1.40/year ($0.35 quarterly); dividend yield =
Share / Stock Price 0.63% — low for a stable company.
TSX Composite average dividend yield has been ~3% historically
Dividend Yield = $1.40 / $223.75 = (1956–2014).
0.63%
Dividend yield rises when stock prices fall (e.g., 1970s inflation,
2008 financial crisis).
Dividends are tax-advantaged in Canada in two key ways:
COMM 309 — Chapter 19: Equity and Hybrid Instruments | Page 3
CHAPTER 19: Equity and Hybrid
Instruments
Comprehensive Exam Preparation Notes
19.1 Shareholders' Equity
Equity securities represent ownership interests in a corporation. Common shares are certificates of this
ownership — common shareholders are the true "owners" of the corporation. Preferred shares provide owners
with a preferential claim to a fixed amount of equity or dividends established at issuance. Importantly, the terms
"common share" and "preferred share" have no statutory definition in Canada under the Canada Business
Corporations Act (CBCA); they describe only different classes of securities within shareholders' equity.
Unlike debt, equity cannot have a fixed contractual commitment — it receives whatever remains after all fixed
commitments are paid. Equity holders are the "residual" claimants on the firm's assets and income.
Consequently, dividends paid on equity are not tax deductible, whereas interest on debt is.
The CBCA 24(3) specifies that, where a corporation has only one class of shares, holders have three fundamental
rights:
• (a) The right to vote at any meeting of shareholders;
• (b) The right to receive any dividend declared by the corporation;
• (c) The right to receive the remaining property of the corporation on dissolution.
Shareholder Rights
The Right to Vote
The most fundamental right of common shareholders is the right to vote. At the annual general meeting (AGM),
shareholders vote on:
• Election of the Board of Directors (BOD), who determine corporate strategy and appoint senior
management;
• Appointment of the firm's auditors;
• Changes to the articles of incorporation and bylaws;
• Major changes in firm operations, such as acquisitions via share exchange or disposition of major assets.
As corporations have grown larger, the "distance" between the firm and its owners has increased, making it
harder for shareholders to enforce rights. Ensuring shareholders can exercise these rights is referred to as
corporate governance.
The Pre-Emptive Right
The pre-emptive right is the right of existing shareholders to maintain their proportional ownership when new
shares are issued. For example, if a firm issues 50% more shares and grants a pre-emptive right, existing
shareholders may buy 50% more shares to maintain their proportional stake. Without this right, the company can
sell shares to new shareholders, diluting existing ownership.
Historically, most new share issues in Canada were made through "rights offerings" to existing shareholders.
Starting in the 1950s, Canadian companies removed the pre-emptive right to sell shares more quickly and
cheaply to institutional investors. Today, very few rights offerings are made in Canada. Firms can issue an
unlimited number of authorized common shares without needing shareholder approval, further concentrating
power in senior management.
📌 AIG Example — Reverse Stock Split and Dilution
COMM 309 — Chapter 19: Equity and Hybrid Instruments | Page 1
, During the 2008–09 financial crisis, the U.S. Federal Reserve needed to take an 80% interest in AIG to
prevent collapse. Because the authorized share count was insufficient, a 1-for-20 reverse stock split was
executed: every 20 existing shares were exchanged for 1 new share, freeing up authorized shares for the
Fed to purchase. AIG's largest shareholder, former CEO Maurice "Hank" Greenberg, saw his ownership
dramatically diluted and sued the U.S. government. The Supreme Court found the actions legal (though the
Fed technically violated rules by buying common shares), recognizing the necessity of saving the financial
system.
Other Rights — Dividends, Dissolution, and Limited Liability
Equity holders are residual owners — they receive dividends and remaining assets only after all other
claimants are paid. Key points:
• No right to a dividend until the BOD declares one. Shareholders cannot legally force dividend payment.
The firm must have resources to pay the dividend without impairing its ability to meet fixed commitments.
• On liquidation, all other claimants on the firm's assets must be paid before equity holders receive anything.
• Limited liability: Equity holders commit initial capital by purchasing shares but are legally protected from
being forced to invest more, even if the firm cannot meet its fixed commitments. Shareholders can only lose
their initial investment — their downside risk is limited, while upside potential is unlimited. This
asymmetry gives common shares characteristics similar to call options.
Different Classes of Shares
The CBCA qualifies the three fundamental shareholder rights by stating they apply "where a corporation has only
one class of shares." When multiple classes exist, the firm must specify in its articles of incorporation how the
three rights are distributed. The only legal requirement is that each of the three rights must be attached to at least
one class of shares.
A typical Canadian share structure example:
📌 Example Share Structure (CBCA Compliant)
Class A Shares (Non-Voting / Limited Voting Shares):
• No voting rights as long as dividends are being paid
• $0.05 extra dividend above Class B, but only if Class C dividends are not in arrears
• Equal share with Class B in residual receipts on winding up
Class B Shares (Common Shares):
• Full voting rights
• No dividends if Class C dividends are in arrears
• Equal share with Class A in residual receipts on winding up
Class C Shares (Preferred Shares):
• No voting rights unless dividends are in arrears for two years, then each share gets one vote
• Fixed dividend of $0.30/share per quarter when declared by BOD; no dividends on Class A or B if Class
C in arrears
• Receives $25 par value before any payments to Class A or B on winding up
Voting and Non-Voting Shares
Voting rights give shareholders control over the BOD and management direction. In takeover situations, voting
shares are more valuable than non-voting shares because an acquirer must buy the voting shares to gain
control — this is called the "control value."
Example — CHUM Ltd. (2006): Bell Globemedia offered $52.50 for Class A (voting) shares and $47.50 for Class
B (non-voting) shares, a $5 premium for control. To prevent similar discrimination for new listings, the TSX
introduced "coattail" provisions requiring all classes of shares to be purchased in a takeover (non-voting shares
"ride the coattails" of voting shares). Companies already listed were grandfathered.
The pattern is common in family-run businesses: founders need external capital but want to maintain control via
multiple voting shares. Example — Four Seasons Hotels (Isadore Sharpe family, 67% of votes through multiple
COMM 309 — Chapter 19: Equity and Hybrid Instruments | Page 2
, voting shares). Problems arise when the founding generation's talent is not inherited — CHUM Ltd. is a classic
example where control passing from the founder led to strategic drift and eventual hostile takeover.
Family Trusts
A family trust is a mechanism that ensures income flows to descendants of the company founder while all votes
are held by the trustees. This separates ownership from control across generations. Example — Ford Motor
Company: 71 million Class B shares (40% of votes) are held in a family trust. All descendants receive income, but
voting control stays with the trustees, even though the Ford family owns only ~2% of the total company equity.
The downside: when family members installed Clay Ford (great-grandson of Henry Ford) as CEO in 2001, Ford's
stock price dropped from ~$20 to under $2 by 2008. Alan Mullaly was eventually brought in as CEO and pledged
Ford's assets to raise capital just before the 2008 crisis, avoiding bankruptcy. Ford's share price recovered to
~$15, though shareholder resolutions to change the share structure continue to receive increasing support.
📌 Key Insight — Dual-Class Shares Trend
The number of dual-class share firms on the TSX has declined significantly — from 168 firms in 1993 to
only 83 by 2009. As the Canadian economy matured, the dominance of family-run businesses with founder
control has decreased. However, the issue remains controversial — at Magna International, Frank
Stronach received an $860-million buyout of his multiple-voting shares — a premium of ~1,800% over the
value of regular shares — sparking an OSC investigation into the fairness of dual-class structures.
Calculating Share Value and Dividend Yield
Using Canadian Pacific (CP) as an example. As of December 31, 2014, CP had 166.1 million shares outstanding
with total common equity of $5,610 million. Key calculations:
Book Value Per Share (BVPS)
BVPS = Common Equity / BVPS indicates the amount of money shareholders have
Number of Shares invested in the firm, either directly or through retained earnings.
CP 2014: BVPS = $5,610M ÷ 166.1M = $33.77
BVPS = $5,610M / 166.1M = $33.77
Market price (P) = $223.75 → reflects current and future
expected profitability.
Market-to-Book Ratio (M/B)
M/B = Price / BVPS A high M/B ratio (>1) indicates the market values the firm well
above its book equity — typical of a growth company.
M/B = $223.75 / $33.77 = 6.63
CP 2014 M/B = 6.63 → regarded as a growth company.
Dividend Yield
Dividend Yield = Dividend per CP 2014: Paid $1.40/year ($0.35 quarterly); dividend yield =
Share / Stock Price 0.63% — low for a stable company.
TSX Composite average dividend yield has been ~3% historically
Dividend Yield = $1.40 / $223.75 = (1956–2014).
0.63%
Dividend yield rises when stock prices fall (e.g., 1970s inflation,
2008 financial crisis).
Dividends are tax-advantaged in Canada in two key ways:
COMM 309 — Chapter 19: Equity and Hybrid Instruments | Page 3
