Preferred Stock | Types of Preferred Stocks | Common Vs Preferred Stocks
Arjun EP
Preferred Stock | Preference Share
Preferred stocks are also called preference shares.
These stocks can be issued only after common stocks.
The persons who purchase preferred stocks are called preferred stockholders (preference shareholders).
Generally, these stockholders have preference rights in the dividend received.
Dividend rates are pre-fixed.
Preferred stockholders get dividends after interest on debenture but before common stockholders.
At the time of winding up, preferred stockholders get money after all the debts but before common stockholders
Types of Preferred Stocks | Types of Preference Share
Cumulative preferred stocks
If the company cannot earn profit for dividends in any financial year, those arrears dividends are accumulated for next year when the company earns a profit.
If the Article of Association (internal rules and regulation of the company) of the company is silent about the accumulated dividends, it is assumed that such stocks or shares are cumulative.
Non-cumulative preferred stocks
If the company cannot earn profit for dividends in any financial year, those arrears dividends are not accumulated for next year, it is known non-cumulative preferred stocks.
These preference shareholders cannot get arrears dividend for next year.
Redeemable preferred stocks
According to the article of association, these shares can be redeemed (buyback) after the expired date.
The terms and conditions of the redemption are specified at the time of issuing.
Irredeemable preferred stocks
These types of shares can be redeemed only at the time of liquidation of the company.
The capital amount of the shares is not paid back to shareholders before the winding up of the company.
Convertible preferred stocks
These types of shares can be converted into other preferred stocks, equity shares, or debentures if mentioned in the Article of Association.
These converting may be at par, at discount or at premium.
All the terms and conditions are mentioned at the time of issuing.
Non-convertible preferred stocks
These types of stocks cannot be converted into other preferred stocks, equity shares or debentures except if not stated.
Participating preferred stocks
These shareholders can get extra or surplus dividends if there remains some dividend after providing the dividend to common stockholders.
First of all, the dividend is shared in a percentage basis.
Then, the remaining dividend is shared on a number of shares ratio to preferred stocks and common stocks.
Non-participating preferred stocks
If the article of association is silent, these shareholders cannot get an extra or surplus dividend.
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Features of Preferred Stocks | Features of Preference Shares
The main features of preferred stocks are given below:
Dividends
The dividend on preferred stocks is prefixed.
Dividend provisions may be cumulative or non-cumulative.
Most shares have cumulative provisions.
If the dividend is not paid by the company, that will be accumulated.
Normally, the firm must pay these unpaid dividends prior to the payment of dividends on the common stock.
Non-cumulative dividends do not accumulate.
Participating
Most preferred stocks are non-participating.
The participating preference shareholder receives a specified dividend plus an extra dividend.
No voting rights
Normally, preferred stocks do not have voting rights.
There is not voting right except in special circumstances.
The cumulative preferred stocks can vote if their dividend is in arrears for 2 years.
The voting right of each preference shareholder is to be in the proportion of the total equity share capital of the company.
Redeemable
If preferred stocks do not have a maturity date, they are similar to equity shares.
But redeemable preferred stocks have maturity time.
Redeemable or callable preferred stocks are redeemed by the payment of a definite price.
The ‘call price or redeemable price’ is set at the time of the shares are issued.
Sinking fund
Generally, preferred stocks are redeemed from sinking funds.
For this purpose, a certain percentage of profits are separated each year.
After some years, when the maturity period of preferred stocks will be completed, shares are redeemed from the sinking fund.
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Advantages of Preferred Stock
The preferred stock has the following advantages and merits:
By the view of a company
No obligation
There is no legal obligation to pay preference dividends.
A company does not face bankruptcy or legal action if it skips preference dividends.
Fixed dividend
Generally, the rate of preference dividend is prefixed.
A dividend is paid according to prefixed.
Thus, preference shareholders do not participate in excess profits as do the ordinary shareholders.
No risk
The preferred stock is a kind of permanent source of finance.
The shareholders cannot be forced into bankruptcy if the dividend cannot be paid.
Increase goodwill
Generally, preference share capital is the part of net worth.
It means preference share capital is added with net worth.
Thus, it increases the goodwill of the firm.
No control
Generally, preferred stocks do not have voting rights.
Therefore, there is no dilution of control.
While financing through preferred stock, the control of the shareholders on the firm is protected.
By the view of an investor
Stable income
Preferred stock provides regular and stable income to the investors.
Because the rate of preference dividend is prefixed.
Priority in assets
In case of liquidation of the firm, generally preferred stockholders are paid before common stockholders.
They have priority before common shareholders.
They will receive a claim on the earnings and assets of the firm.
Tax exemption
Most companies like to purchase preferred stock as an investment.
Because, dividend received on preferred stock is tax-exemption.
Disadvantages of Preferred Stock
The preferred stock has the following disadvantages and limitations:
By the view of a company
High cost
Generally, preferred stocks are costly, because the dividend rate on such shares is higher than an interest rate of debts, bonds or debentures.
Difficult to sale
The preference shareholders take more risk than the bondholders.
In case of liquidation of the firm, bondholders are paid before preferred stockholders.
Therefore, it is difficult to sell preference shares in the market.
Prior right
In case of liquidation of the firm, preferred stockholders have priority on a claim.
They will receive a prior claim on the assets and earnings of the firm.
By the view of an investor
No voting rights
The preference shareholders do not have voting rights in the affairs of the company.
They cannot elect the board of directors and management of the company.
Limited income
The return on preferred stock is limited.
Therefore, the investors may not like to invest in preferred stock.
More fluctuation
The price of a preferred stock fluctuates more than bond or debt.
Sometimes, returns on bonds are higher than preferred stocks.
Differences between Equity Shares and Preferred Stocks
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Bases |
Common stock |
Preferred stock |
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Meaning |
Equity shares are the base capital of a limited company. |
A limited company can issue preference shares only after issuing equity shares. |
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Name of investors |
The person who purchases equity shares is called equity shareholder. |
The person who purchases preferred stocks is called a preference shareholder |
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Reward for investors |
Common stockholders receive the dividend. |
Preference shareholders receive preference dividend |
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Fluctuation of reward |
The dividend rate may be different from year to year. |
Lack of information, preference dividend rate is fixed. |
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Voting right
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All the common stockholders have voting right. |
Only specific preference shareholders have voting right. |
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Redemption |
Equity shares can never be redeemed. |
Most of the preferred stocks are redeemable. |
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