ACCA Advanced Financial Management (AFM) Practice Exam

What rights do common stockholders have regarding company financials?

1. Access to all company contracts

2. Rights to residual cash flows

3. Priority repayment over debt holders

4. Rights to participate in management decisions

The correct answer is: Rights to residual cash flows

Common stockholders have the right to residual cash flows, which means they are entitled to any profits a company generates after all expenses, obligations, and debts have been paid. This residual claim on the earnings is an essential characteristic of equity financing, as it reflects the ownership stake that common stockholders have in the company. When a company declares dividends, it distributes a portion of these residual profits to common stockholders. However, they receive payment only after all creditors, including bondholders and preferred stockholders, have been paid. This structure highlights the risk that common stockholders bear since they may receive little or nothing if a company does not perform well financially. The other options involve rights that are not typically afforded to common stockholders. Access to all company contracts is generally not a right of common stockholders as such details remain confidential and are not disclosed publicly. Priority repayment over debt holders misrepresents the risk hierarchy in capital structure; common stockholders are last in line for any repayments upon liquidation. Rights to participate in management decisions may hold true indirectly through voting rights during shareholder meetings, but this doesn't encompass broader financial rights typically associated with financial statements and cash flows. Therefore, the primary and defining right of common stockholders in this context pertains to their claim