Preferred Stock

Definition

Preferred stock is a type of equity security that gives shareholders preferential treatment in terms of dividend payments and asset distribution during liquidation. It usually provides a fixed dividend, making it less risky compared to common stock, but it typically does not carry voting rights. This unique positioning makes preferred stock relevant in understanding the structure of corporate financing, stock markets, capital costs, and the implications for multinational corporations.

5 Must Know Facts For Your Next Test

1. Preferred stockholders have a higher claim on assets and earnings than common stockholders, especially during bankruptcy or liquidation events.
2. Dividends on preferred stock are often fixed and paid before any dividends are distributed to common stockholders.
3. Some preferred stocks come with conversion features, allowing holders to convert their shares into common stock under certain conditions.
4. In many cases, preferred stock can be callable, meaning the issuing company has the right to buy back shares at a predetermined price after a certain date.
5. Preferred stock can be cumulative or non-cumulative; cumulative preferred stock accrues unpaid dividends, while non-cumulative does not.

Review Questions

• How does preferred stock differ from common stock in terms of dividends and rights associated with ownership?
  • Preferred stock differs from common stock primarily in its dividend structure and ownership rights. Preferred stockholders receive fixed dividends that must be paid out before any dividends are distributed to common stockholders. Additionally, preferred shares usually do not grant voting rights, whereas common stockholders typically have a say in company decisions through their voting power. This hierarchy in dividend distribution and control illustrates the distinct roles that each type of equity plays in corporate governance and finance.
• Discuss the implications of including preferred stock in a company’s capital structure and its impact on the weighted average cost of capital (WACC).
  • Including preferred stock in a company's capital structure can significantly impact its weighted average cost of capital (WACC). Since preferred stock generally offers fixed dividends, it tends to have a lower cost compared to common equity. This can reduce overall WACC, making it cheaper for companies to finance projects. However, the inclusion of preferred stock must be balanced against potential dilution of control for common shareholders and the obligation to meet dividend payments, which could affect cash flow management.
• Evaluate how preferred stock can affect multinational corporations' strategies in capital financing across different countries.
  • Preferred stock can play a strategic role for multinational corporations by providing flexibility in capital financing while managing risk across diverse regulatory environments. Different countries may have varying tax treatments for dividends on preferred shares compared to debt financing. By issuing preferred stock, multinational companies can attract investors seeking stable returns without increasing their debt burden. This approach allows companies to optimize their capital structure while adapting to local market conditions and investor preferences, ultimately influencing their growth strategies and investment opportunities globally.

Related terms

Common Stock: Common stock represents ownership in a company and typically comes with voting rights, but dividends are not guaranteed and can vary.

Dividend: A payment made by a corporation to its shareholders, usually derived from profits, which can be regular or special based on the company's financial performance.

Capital Structure: The mix of a company's long-term debt, short-term debt, common equity, and preferred equity that defines its funding and financial strategy.