Preferred Shares are a unique class of equity ownership in a corporation. They provide specific benefits not available to common shareholders, such as fixed dividends and priority in asset distribution upon liquidation. These shares typically do not confer voting rights in the company’s corporate decisions, which distinguishes them from common shares.
Characteristics of Preferred Shares
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Fixed Dividends: Preferred shares typically have a predetermined dividend rate, offering more predictable income compared to the fluctuating dividends of common shares.
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Priority in Dividends: Holders of preferred shares receive dividends before common shareholders. In situations where companies must skip dividends, preferred dividends are usually cumulative, meaning unpaid dividends accumulate and must be paid out before any dividends can be issued to common shareholders.
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Liquidation Preference: If a company goes bankrupt and undergoes liquidation, preferred shareholders have a higher claim on the company’s assets than common shareholders after debt obligations have been fulfilled.
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Lack of Voting Rights: Preferred shareholders generally do not have voting rights, meaning they do not influence corporate policy or management decisions.
Types of Preferred Shares
Preferred shares come in various forms, each with distinct attributes:
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Cumulative Preferred Shares: These shares accumulate unpaid dividends, which must be paid out before dividends can be issued to common shareholders.
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Non-Cumulative Preferred Shares: These do not accumulate unpaid dividends. If a company decides not to pay a dividend in a given year, shareholders lose the right to claim it in the future.
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Convertible Preferred Shares: These can be converted into a specified number of common shares, often at the shareholder’s discretion.
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Callable Preferred Shares: The issuing company can buy back these shares at a predetermined price after a certain date.
Historical Context of Preferred Shares
Preferred shares have been a vital component of corporate finance since the late 19th century. They were originally used by railroads and utility companies to raise capital quickly without diluting the control of existing common shareholders. Over the years, various industries have adopted preferred shares due to their flexibility and investor appeal.
Applicability in Modern Finance
Preferred shares are favored by certain investors who prioritize stable income streams over potential capital appreciation seen in common stocks. They cater particularly well to income-focused investors, such as retirees, and institutional investors, who seek predictable returns and lower volatility.
Related Terms
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Common Shares: Equity ownership in a corporation that typically confers voting rights but dividends are variable and secondary to preferred shares.
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Dividends: A portion of a company’s earnings distributed to shareholders.
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Convertible Securities: Financial instruments that can be converted into another form of security, typically common shares.
FAQs
Q: Can preferred shares appreciate in value? A1: While preferred shares can appreciate, they generally offer less capital gain potential compared to common shares. Their value is mostly driven by interest rate changes and the company’s credit quality.
Q: What happens to preferred shares during a company’s liquidation? A2: In liquidation, preferred shareholders receive payment before common shareholders but after bondholders and other debt collectors.
Q: Are preferred shares a good investment? A3: Preferred shares can be a good investment for those seeking stable income with higher priority on dividends and lower risk than common shares. However, they may not suit investors looking for capital growth or voting influence.
References
- Brealey, R.A., Myers, S.C., & Allen, F. (2020). Principles of Corporate Finance.
- Mishkin, F. S., & Eakins, S. G. (2018). Financial Markets and Institutions.
- Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset.
Summary
Preferred shares offer a unique blend of benefits and limitations. They provide a more predictable income stream through fixed dividends and priority in asset distribution over common shares. However, they usually do not confer voting rights, which limits shareholder influence. Preferred shares can be a wise investment for those seeking stability and income rather than capital gains and decision-making power.
Preferred Shares remain a pivotal financial instrument in corporate finance, appealing particularly to income-focused and risk-averse investors.
