How the Stock Market Works

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Enterprise value equals market capitalisation plus total debt minus cash and cash equivalents. Market cap here is 10 million shares times $50, which is $500 million. Adding $100 million in debt gives $600 million, but the precise EV depends on how much cash the company holds — cash is subtracted because an acquirer effectively receives it back. The option stating EV equals market cap alone ignores the debt holders' claim on the business. The option subtracting debt from market cap reverses the formula. The option adding debt without mentioning the cash adjustment is incomplete, though it would be correct only in the special case where cash is zero.

Source: CFA Institute, 'Enterprise Value' definition in Equity Valuation curriculum

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A 2-for-1 stock split doubles the number of outstanding shares while halving the price per share, leaving each shareholder's total position value unchanged. The investor's 100 shares at $40 become 200 shares at $20, still worth $4,000 in total. The option claiming the price doubles confuses a split with a reverse split. The option claiming both shares and market cap double would mean the company magically created new value from an accounting action. The option describing a halving of shares describes a reverse split, not a forward split.

Source: SEC, Investor.gov, 'Stock Splits'

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A market order instructs the broker to buy immediately at the best available price, guaranteeing execution but not a specific price — in fast-moving or illiquid markets the fill price can differ from the last quoted price. A limit order sets a ceiling price for a buy (or a floor for a sell) and only executes at that price or better, meaning it may never fill if the market never reaches the specified level. The option claiming limit orders always execute faster is wrong; they often sit unfilled. The option restricting market orders to regular hours is incorrect; order-type availability depends on broker and exchange rules, not inherently on the order type. The option calling them interchangeable misunderstands a fundamental distinction in order mechanics.

Source: SEC, Investor.gov, 'Types of Orders'

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Common stock represents a residual ownership claim on a company's assets and earnings, not a promise of fixed payment. Shareholders benefit if the company grows in value or pays dividends, but neither is guaranteed, and in liquidation common shareholders are paid only after creditors, bondholders, and preferred shareholders have been satisfied. The option describing a guaranteed fixed interest payment describes a bond, not common stock — bonds contractually obligate a fixed coupon regardless of performance, while stock returns fluctuate with company performance. The option describing a short-term loan repaid by a fixed maturity date also describes debt, not equity — stock has no maturity date and is never repaid by the company. The option describing a guaranteed fixed dollar claim on profits ignores that no dividend or profit share is contractually fixed or guaranteed for common shareholders; even preferred stock's fixed dividend, unlike common stock, is a contractual preference but still not an absolute guarantee, since it can be suspended.

Source: SEC, Investor.gov — 'What Is a Stock?'

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Preferred stock sits between debt and common equity in a company's capital structure. It typically pays a fixed dividend, often expressed as a percentage of par value, that must be paid before any dividend to common shareholders, and preferred shareholders also have priority over common shareholders in receiving proceeds if the company is liquidated. In exchange for this priority, preferred stock usually carries no voting rights on corporate matters. The option claiming preferred shareholders get greater voting power reverses the actual tradeoff — preferred stock generally sacrifices voting rights in exchange for payment priority. The option claiming preferred and common prices move in lockstep is wrong because preferred stock behaves more like a bond, with its price sensitive to interest rates and dividend reliability rather than moving identically with common equity, which reflects growth expectations. The option describing it as debt with a maturity date confuses preferred stock with a bond; preferred stock is equity and, unless specifically structured as callable, has no stated repayment date.

Source: CFA Institute, Equity Investments curriculum — 'Preferred Stock'

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The primary market is where securities are created and sold for the first time — in an IPO, the company issues new shares directly to investors and receives the proceeds. The secondary market is where existing shares change hands between investors after that; the company is not a party to these later trades and receives no proceeds from them. The option claiming both transactions are primary-market trades ignores that only the original issuance involves the company as a counterparty; after the IPO, the company has no direct role in trades between other investors. The option reversing the definitions swaps the two markets' meanings entirely. The option claiming there's no meaningful distinction ignores a foundational distinction in securities markets — regulatory requirements, such as SEC registration for new offerings, and who actually receives the sale proceeds differ materially between the two.

Source: SEC, Investor.gov — 'Primary and Secondary Markets'

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Outstanding shares are the shares currently held by outside investors, calculated as total issued shares minus any shares the company has repurchased and holds as treasury stock. Here, 60 million issued minus 10 million held in treasury leaves 50 million outstanding. The option equating outstanding shares with authorized shares confuses the maximum a company is legally permitted to issue with what has actually been issued and remains in investors' hands — authorized shares, 100 million here, is simply a ceiling set in the corporate charter. The option equating outstanding shares with all issued shares ignores that treasury shares, while technically issued at some point, are no longer counted as outstanding once repurchased — they carry no voting rights and receive no dividends while held by the company. The option subtracting treasury shares from authorized shares mixes two unrelated figures; treasury shares must be subtracted from issued shares, not from the authorized ceiling, to reach the correct outstanding count.

Source: U.S. SEC, EDGAR filer guidance — Form 10-K cover page instructions on shares outstanding, authorized, and treasury shares

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EPS is calculated as net income divided by weighted-average shares outstanding. Repurchasing shares reduces the denominator without changing the numerator, net income, so EPS mechanically rises: $100 million divided by 40 million shares equals $2.50, up from $2.00. This is one reason companies sometimes conduct buybacks — doing so can boost EPS even without any improvement in underlying profitability. The option showing EPS falling to $1.60 has the mechanics backward — a shrinking share count divided into unchanged income increases the per-share figure, it doesn't decrease it. The option claiming EPS stays unchanged ignores that EPS is explicitly a per-share figure, and shrinking the share count is precisely the kind of change that mechanically alters it, unlike, say, a change in the stock's trading price. The option claiming EPS becomes undefined confuses the buyback's effect on the balance sheet and share count with a required adjustment to net income; net income used in the EPS calculation is not reduced by the cash spent on the buyback.

Source: CFA Institute, Corporate Issuers curriculum — 'Share Repurchases and Earnings Per Share'

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In a short sale, the investor borrows shares and sells them, receiving cash, but is obligated to eventually buy an equal number of shares on the open market to return to the lender — this closing purchase is called covering the short. Because a stock's price can theoretically rise without limit, the cost to buy back the borrowed shares can keep growing indefinitely, making the short seller's potential loss theoretically unlimited. This contrasts with a standard long position, where the maximum possible loss is capped at the original amount invested, since a stock's price cannot fall below zero. The option claiming the position closes automatically at the original sale price is incorrect — a short position remains open, accruing profit or loss, until the investor actively buys back the shares. The option capping the maximum loss at the sale proceeds ignores that losses grow as the price rises past the sale price, with no upper bound. The option describing short selling as identical to buying on margin reverses the direction of the bet entirely — margin buying is a bet the price rises, while short selling is a bet the price falls.

Source: SEC, Investor.gov — 'Short Sales'

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Market capitalization — the standard measure used to classify companies as large-cap, mid-cap, or small-cap — equals share price multiplied by total shares outstanding, not share price or share count alone. Company A's market cap is 500 million shares times $4, or $2 billion; Company B's is 20 million shares times $150, or $3 billion. Despite having a much lower share price and far fewer shares outstanding, Company B has the larger market capitalization and would be classified as the bigger company by this standard measure. The option focused on share count alone ignores price entirely, and the option focused on price alone ignores share count entirely — both miss that market cap requires multiplying the two together. The option calling a low share price a 'penny stock' indicator confuses share price level with company size; a low nominal share price says nothing by itself about total market value, and penny stock is a specific, much lower price-and-market-cap classification that doesn't apply to either company here.

Source: SEC, Investor.gov — 'Market Capitalization'

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While there is no single official legal definition, the widely used market convention defines a bear market as a decline of roughly 20% or more from a recent peak, with a bull market correspondingly describing a sustained rise. This 20% threshold is the figure most consistently cited by financial commentators, index providers, and research firms tracking market cycles. The option based on three consecutive down days describes ordinary short-term volatility, not the sustained, large-magnitude decline the term bear market is meant to capture. The option based on trading volume relative to a moving average measures liquidity and investor interest, not price decline, and isn't part of the bear-market convention. The option requiring a 50% decline in a majority of individual stocks sets an arbitrary and far more extreme bar than the commonly used index-level 20% threshold, and conflates individual stock performance with the aggregate index measure the term actually refers to.

Source: FINRA, Investor Education — 'Bear Markets and Bull Markets'

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In a market-capitalization-weighted index like the S&P 500, each constituent's weight is proportional to its total market value, share price times shares outstanding, so a company with a large total market cap moves the index significantly even if its individual share price is relatively low. In a price-weighted index like the DJIA, weight is determined purely by the nominal share price, without regard to shares outstanding or total company size, so a company with a high share price swings the index disproportionately even if its overall market capitalization is comparatively modest. The option claiming equal weighting for every constituent misdescribes both index methodologies, neither of which weights constituents equally. The option claiming a market-cap-weighted index discounts low-price companies gets the mechanism backward — it is total market value, not per-share price, that determines weight in that index, so a low price with a large enough share count still yields large weight. The option claiming market cap and share price always move together for large companies is false; the two can diverge widely depending on how many shares a company has chosen to have outstanding, which is exactly why the two index methodologies produce such different behavior.

Source: CFA Institute, Market Organization and Structure curriculum — 'Index Weighting Methods: Market-Capitalization-Weighted vs. Price-Weighted'

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Total return captures every source of gain an investor actually receives from holding a stock, both the change in price and any cash dividends paid, expressed as a percentage of the starting price. Here, the $6 price gain plus the $2 dividend equals $8 of total gain on a $100 starting price, for an 8% total return. Price return, sometimes called capital appreciation, counts only the change in the stock's price and ignores dividends entirely, giving a smaller 6% figure in this example. The option claiming dividends are excluded from return calculations by regulation is simply incorrect; there is no such rule, and total return calculations routinely include dividends because they are real cash received by the shareholder. The option claiming both figures are identical ignores that the dividend adds real value to the investor's outcome beyond the price change alone. The option that swaps the two figures, assigning 2% to total return and 8% to price return, has the definitions backward: total return is the larger, more inclusive figure here, since it adds the dividend on top of the price gain, not the smaller, dividend-only figure.

Source: SEC, Investor.gov / CFA Institute curriculum — 'Total Return vs. Price Return'

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Par value is an arbitrary, nominal amount a company states in its corporate charter when stock is first authorized, and it exists mainly for legal and accounting bookkeeping purposes, such as setting the 'legal capital' line on the balance sheet. It is set once, essentially never changes, and has no ongoing connection to what the stock actually trades for, which is instead driven entirely by market supply, demand, and investor expectations about the business. The option describing it as a legal minimum selling price confuses par value with a price floor; companies routinely raise large amounts of capital at new-issue prices far above par, and par value imposes no such restriction. The option describing it as the company's own estimate of intrinsic value mistakes a fixed legal formality for a dynamic valuation judgment that par value was never designed to express. The option describing it as the original issue proceeds is also wrong: companies almost always receive far more than par value when shares are first sold, with the excess recorded separately as additional paid-in capital rather than folded into par itself.

Source: Investopedia, 'Par Value: What It Is, How It's Used for Stocks and Bonds'

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In its classic form, a direct listing lets a company put its existing, already-outstanding shares straight onto a public exchange without issuing any new shares and without hiring underwriters to buy, pre-price, and resell an offering to public investors. Instead, the opening trade price is discovered through the exchange's opening auction, matching real buy and sell orders from the market, which is why no capital is raised and no underwriting fee is paid. The option describing a traditional IPO is wrong because an IPO involves newly created shares priced in advance through negotiation between the company and its underwriters, who then sell those shares to investors. The option describing a forward stock split is wrong because a split merely multiplies the number of existing shares at a proportionally lower price per share, with no change in total market value or public float, and involves no transition to being publicly traded at all. The option describing a secondary offering is wrong because that refers to an already-public company selling additional shares later, not a private company's initial move onto an exchange.

Source: NYSE, 'Direct Listings' (choose-your-path-to-public issuer guidance)

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A preemptive right, sometimes called a subscription right or anti-dilution right, lets an existing shareholder buy enough of a new share issuance to keep their percentage ownership of the company unchanged, by purchasing new shares in proportion to what they already hold, before the company offers those shares to outside investors. It is a right, not an obligation: the shareholder can choose not to participate and accept the resulting dilution instead. The option describing a cash payment with no buying option is wrong because the entire point of the right is the ability to buy shares and preserve one's stake, not to be cashed out of it. The option describing a binding veto is wrong because a preemptive right controls how much of a new issuance an individual shareholder may buy; it does not give any single shareholder the power to stop the company from issuing shares at all. The option describing free bonus shares is wrong because preemptive rights require the shareholder to pay for the new shares they purchase at the offering terms, not receive them at no cost, which would instead resemble a stock dividend.

Source: Cornell Law School, Legal Information Institute (LII) Wex — 'Preemptive right'

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When a company sells brand-new shares in a primary follow-on offering rather than existing holders simply reselling shares they already own, the total number of shares outstanding grows, from 10 million to 15 million here, while the original investor's own holding stays fixed at 1 million shares. Ownership percentage is always a share of that growing total, so 1 million divided by 15 million works out to about 6.7%, down from 10%, even though the investor did nothing and lost no shares. The option claiming the percentage stays at 10% confuses holding the same number of shares with holding the same proportional stake, which is exactly what dilution mechanically breaks. The option claiming the percentage rises is wrong because additional capital raised benefits the company's balance sheet as a whole, not this investor's unchanged slice of a now-larger share count. The option claiming a fixed fall to 5% wrongly assumes dilution always halves a stake regardless of how many new shares are actually issued relative to the prior total, which depends entirely on the specific numbers involved.

Source: Corporate Finance Institute, 'Seasoned Equity Offering (Follow-on Offering)'

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Growth and value are style classifications describing why investors are willing to own a stock, not its market capitalization or industry. Company X fits the growth label: a high price relative to current earnings, profit reinvested rather than distributed, and a thesis resting on earnings expanding faster than the market average going forward. Company Y fits the value label: a low price relative to current earnings, a relatively higher dividend typical of mature businesses with fewer reinvestment opportunities, and a thesis resting on the market currently underpricing an already-stable business rather than on future expansion. The option swapping the two labels reverses this entire contrast, mistaking heavy reinvestment, a growth-stock trait, for a value characteristic. The option labeling both as growth stocks is wrong because market capitalization being similar says nothing about how each is priced relative to earnings or why investors buy it, which is what the classification actually tracks. The option labeling both as value stocks is wrong for the same reason, and additionally ignores that Company X's lack of a dividend and high earnings multiple are themselves hallmarks of growth rather than value investing.

Source: Corporate Finance Institute, 'Growth Stocks vs Value Stocks'

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A dual-class structure separates voting power from economic ownership. Because Class B shares carry ten votes each while Class A shares carry one, the founders can control a majority of total votes, and therefore control board elections and other matters put to a shareholder vote, even while holding a minority of the company's total equity value and economic upside. The option about dividend priority is wrong because the question states both classes have identical economic rights, including dividends and liquidation proceeds; the dual-class split affects only voting power, not payout priority. The option claiming founders are legally barred from ever selling their high-vote shares is wrong: dual-class plans typically allow sales, though many plans convert high-vote shares to single-vote shares automatically upon transfer to an outside party, which is a conversion-on-transfer feature, not an outright prohibition on selling. The option about automatic conversion triggered by a net loss is wrong because conversion provisions in real dual-class structures are typically tied to share transfers or sunset dates, not to a single quarter or year of reported losses.

Source: U.S. SEC EDGAR S-1/IPO prospectus disclosures describing dual-class common stock structures (differential per-share voting rights between Class A and Class B common stock, as commonly disclosed in registration statements)

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Proxy voting lets a shareholder who cannot attend the annual meeting in person still exercise their default one-vote-per-share on the items listed, by authorizing another party, often a member of management or an independent proxy service, to cast those votes exactly as instructed. Legal ownership of the shares never changes hands; only the limited authority to vote them at that specific meeting is delegated, and it expires once the meeting concludes. The option describing a 'binding guarantee' of an election outcome is wrong because a proxy vote simply gets counted at face value like any other vote; it carries no extra weight and guarantees no outcome. The option describing a transfer of legal share ownership is wrong because a proxy is strictly a limited voting authorization, not a change in who owns the underlying shares. The option about bundling shares to reach a minimum voting threshold is wrong because there is no minimum ownership threshold required to vote; any shareholder, down to a single share, is already entitled to vote that share directly or by proxy.

Source: SEC Regulation 14A (federal proxy rules) and standard proxy statement (Schedule 14A/DEF 14A) disclosures describing default one-share-one-vote arrangements and proxy voting mechanics

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The comprehensive, audited annual report is the 10-K, the condensed and generally unaudited quarterly update is the 10-Q, and the prompt disclosure of a major unscheduled event, filed within days rather than on a fixed quarterly or annual schedule, is the 8-K. The option swapping the annual and quarterly labels, and naming S-1 as the current-event report, is wrong because S-1 is actually the registration statement a company files to register securities before or when it first goes public, not a recurring disclosure used by an already-public company for ongoing events. The option that labels 8-K as the quarterly report and 10-Q as the current-event report is wrong because it reverses their actual purposes: the 8-K is event-driven and filed promptly after specific triggering events, while the 10-Q is scheduled and tied to each fiscal quarter's close. The option using S-1 as the annual report and swapping 10-K and 10-Q is wrong for the same reason as the first distractor, compounded by also reversing the annual/quarterly pairing.

Source: U.S. SEC, EDGAR Full Text Search — General Instructions to Form 10-K, Form 10-Q, and Form 8-K (Securities Exchange Act of 1934 periodic and current reporting requirements)

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A tender offer sets a fixed, publicly announced price, usually at a premium to the prevailing market price, and a firm deadline, leaving each shareholder free to decide how much, if any, of their stake to sell at that price. An open-market repurchase program instead has the company act like any other buyer on the exchange, purchasing shares gradually over time at whatever price the market happens to set, with no fixed price or hard deadline, which gives the company far more flexibility in timing and amount. The option that swaps which method is which is wrong because it reverses these defining features: a formal tender, not an open-market program, is the one with the fixed price and deadline. The option claiming the two methods are legally identical paperwork-only variants is wrong because they differ in price mechanism, shareholder participation mechanics, and applicable securities rules, not just filing requirements. The option describing one method as a disguised stock split and the other as the only legitimate repurchase method is wrong because both are genuine, separately recognized, and commonly used buyback methods, neither of which is a stock split.

Source: Investopedia verified articles on 'Tender Offer' and 'Open Market Repurchase'

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Scenario 1 creates brand-new shares that the company itself sells, which increases total shares outstanding, dilutes existing holders proportionally, and sends the cash raised onto the company's own balance sheet, the hallmark of a primary offering, here specifically a follow-on primary offering since the company already trades publicly. Scenario 2 involves no new shares at all; an existing holder simply sells shares she already owns to new investors, so total shares outstanding is unchanged and the proceeds go to her personally rather than to the company, which is the defining feature of a secondary offering. The option reversing these two labels is wrong because it inverts which scenario dilutes existing holders and which merely transfers already-outstanding shares between investors. The option calling both scenarios an 'IPO' is wrong because the company already trades publicly from an offering two years earlier; neither scenario is its initial public offering. The option labeling the scenarios a stock split and a tender offer is wrong because neither scenario involves subdividing existing shares, as a split would, nor the company itself buying back shares, as a tender offer would.

Source: U.S. SEC Compliance and Disclosure Interpretations, Securities Act Sections, C&DI 612.09 (distinguishing primary from secondary stock offerings)

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Under Nasdaq's minimum bid price rule, a company that falls out of compliance is first given a compliance period, commonly up to 180 calendar days, during which its closing price must reach and hold at $1.00 or more for a minimum run of consecutive trading days before Nasdaq will consider it cured; only once that cure period is exhausted without success does Nasdaq proceed toward a delisting determination, which the company may still appeal. The option describing immediate, same-day permanent delisting is wrong because Nasdaq's process is explicitly structured around a notice-and-cure period rather than instant removal. The option invoking automatic SEC revocation of the company's registration is wrong because a stock exchange's minimum-price listing standard is an exchange rule, not a direct SEC deregistration action, and the two processes are legally distinct. The option describing an automatic conversion into a price-requirement-free share class is wrong because no such automatic escape mechanism exists under Nasdaq's listing rules; the company must either cure the deficiency, pursue limited extensions where eligible, or face delisting.

Source: Nasdaq Listing Rule 5810(c)(3)(A) — Minimum Bid Price Requirement, compliance and cure period provisions

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Under Section 16 of the Securities Exchange Act of 1934, as tightened by the Sarbanes-Oxley Act of 2002, officers, directors, and beneficial owners of more than 10% of a company's stock must report most transactions in that stock, including ordinary open-market purchases, on Form 4 by the end of the second business day following the transaction. The option citing Form 3 and a 10-day window is wrong because Form 3 is a one-time initial filing due when someone first becomes an officer, director, or 10%-plus owner, reporting their starting position, not an ongoing transaction report. The option citing Form 5 and a 45-day annual window is wrong because Form 5 is an annual catch-all used mainly for transactions eligible for deferred reporting, such as certain gifts, not for routine open-market purchases that must already be reported on Form 4. The option claiming there is no federal deadline is wrong because Section 16 imposes a specific, mandatory, short reporting deadline precisely to curb delayed or hidden insider trading disclosure.

Source: Securities Exchange Act of 1934, Section 16, as amended by the Sarbanes-Oxley Act of 2002 (two-business-day Form 4 filing deadline for officers, directors, and 10%-plus beneficial owners)

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A shareholder rights plan, commonly called a poison pill, is designed so that once an outside acquirer crosses a set ownership threshold, often set roughly in the 10% to 20% range, without board approval, every other shareholder can buy additional shares at a steep discount, sharply increasing the total share count held by everyone except the triggering acquirer. This dilutes the acquirer's percentage stake and voting power so severely that completing or holding onto a hostile position becomes prohibitively expensive, which in practice pushes the acquirer to negotiate directly with the board rather than proceed unilaterally. The option claiming it legally bars any further purchases by the acquirer is wrong because the plan does not prohibit purchases outright; it instead makes crossing the threshold economically punishing through dilution. The option describing a guaranteed cash payout to all shareholders is wrong because the plan grants a right to buy discounted shares, not a cash distribution. The option describing automatic conversion to a private company is wrong because triggering a rights plan dilutes an acquirer's stake; it does not itself take the company private or delist it.

Source: Delaware Supreme Court, Moran v. Household International, Inc. (Del. 1985), establishing the legality of shareholder rights plans; standard 'poison pill' mechanics as described in corporate-governance legal literature