Historical Context
Preference shares have been a part of the corporate landscape for over a century. Originating in the early 19th century, they were designed to attract investors by offering a fixed return in the form of dividends, while minimizing control over the company. Preference shares have since evolved, offering varied structures to suit different financial needs and investor preferences.
Types of Preference Shares
1. Cumulative Preference Shares:
These shares accumulate unpaid dividends. If a company skips dividends, they owe them in future profitable years.
2. Non-Cumulative Preference Shares:
Dividends do not accumulate if not declared. Shareholders lose the right to dividends if a company does not declare them in a given year.
3. Convertible Preference Shares:
These shares can be converted into a specified number of ordinary shares after a predefined period.
4. Non-Convertible Preference Shares:
These shares cannot be converted into ordinary shares and remain preference shares throughout their term.
5. Participating Preference Shares:
Shareholders may receive additional dividends if the company performs exceptionally well, over and above the fixed dividend.
6. Redeemable Preference Shares:
The company has the right to redeem these shares after a certain period or under specific conditions.
Key Features
- Dividend Priority: Preference shareholders receive dividends before ordinary shareholders.
- No Voting Rights: Typically, preference shares do not carry voting rights in general meetings of the company.
- Fixed Dividends: They often have a fixed dividend rate, providing regular income to investors.
- Priority in Liquidation: In the event of company liquidation, preference shareholders are paid before ordinary shareholders but after debt holders.
Mathematical Models and Examples
Dividend Calculation for Cumulative Preference Shares
Given:
- Dividend rate: 5%
- Face value of share: $100
- Number of shares: 1,000
If the company skipped dividends in the past two years, the accumulated dividend for one year is:
Mermaid Chart Example:
pie
title Dividend Distribution
"Cumulative Preference Shareholders": 50
"Non-Cumulative Preference Shareholders": 30
"Ordinary Shareholders": 20
Importance and Applicability
Preference shares are crucial for both companies and investors. They help companies raise capital without diluting control, offering a stable dividend to attract conservative investors. For investors, they provide a predictable income stream and relatively lower risk compared to ordinary shares.
Comparisons
- Preference Shares vs. Ordinary Shares:
- Dividend: Preference shares have fixed dividends; ordinary shares do not.
- Voting Rights: Ordinary shares typically have voting rights; preference shares do not.
- Priority: Preference shares have priority over ordinary shares for dividends and during liquidation.
Related Terms
- Equity Shares: Common stocks representing ownership in a company with voting rights but no fixed dividends.
- Debentures: Long-term securities yielding a fixed interest rate, used by companies to borrow money.
Interesting Facts
- The highest-ever dividend paid on preference shares was by Ford Motor Company, issuing $1.18 billion to preference shareholders.
- Some companies issue preference shares to institutional investors to maintain tight control over voting rights.
FAQs
**Q: Can preference shareholders vote in a company’s AGM?**
**Q: Are dividends on preference shares guaranteed?**
Quotes
- Warren Buffett: “In the business world, the rearview mirror is always clearer than the windshield.”
Summary
Preference shares provide a middle ground between debt and equity, offering fixed dividends and priority claims without voting rights. They are instrumental in corporate finance, balancing the interests of conservative investors and companies seeking to raise capital without diluting control. Understanding preference shares’ nuances helps investors make informed decisions while broadening financial knowledge.
References
- Brealey, R.A., Myers, S.C., & Allen, F. (2011). Principles of Corporate Finance. McGraw-Hill.
- Ross, S.A., Westerfield, R.W., & Jaffe, J. (2008). Corporate Finance. McGraw-Hill.
By exploring the fundamentals of preference shares, their types, and their strategic importance, this article serves as a detailed guide for investors, financial analysts, and corporate finance enthusiasts.
