Preferred Shares

Definition

Preferred shares, also known as preference shares, are a type of equity security that provide shareholders with certain priority rights over common shareholders. Preferred shares typically offer a fixed dividend payment and have a higher claim on a company's assets compared to common stock, making them a hybrid between debt and equity instruments.

5 Must Know Facts For Your Next Test

1. Preferred shares generally have a higher claim on a company's assets and earnings compared to common stock, which means they receive dividends before common shareholders.
2. Preferred shares often have a fixed dividend rate, providing shareholders with a predictable income stream, unlike the variable dividends of common stock.
3. Preferred shareholders typically do not have voting rights, unlike common shareholders, but they have a higher priority claim on the company's assets in the event of liquidation.
4. Convertible preferred shares allow shareholders to convert their shares into a predetermined number of common shares, providing the opportunity to participate in the company's growth.
5. Callable preferred shares give the issuing company the right to redeem the shares from shareholders at a predetermined price, often after a specified period of time.

Review Questions

• Explain the key features that distinguish preferred shares from common shares.
  • The key features that distinguish preferred shares from common shares are: 1) Preferred shareholders have a higher claim on a company's assets and earnings, receiving dividends before common shareholders. 2) Preferred shares often have a fixed dividend rate, providing a predictable income stream. 3) Preferred shareholders typically do not have voting rights, unlike common shareholders. 4) Preferred shares can be convertible, allowing shareholders to participate in the company's growth, or callable, giving the issuing company the right to redeem the shares at a predetermined price.
• Describe the role of preferred shares as an alternative source of funds for a company, as discussed in the context of Section 17.6 of the course.
  • In the context of Section 17.6 on Alternative Sources of Funds, preferred shares can serve as an important alternative source of financing for a company. Compared to debt, preferred shares provide a way for companies to raise capital without taking on additional debt obligations. Preferred shares also offer a higher claim on assets and earnings than common stock, making them attractive to investors seeking a more stable and predictable return. The various features of preferred shares, such as cumulative dividends, convertibility, and callability, allow companies to tailor the financing to their specific needs and market conditions.
• Analyze how the characteristics of preferred shares, such as their priority claim and fixed dividends, can impact a company's capital structure and financial flexibility.
  • The characteristics of preferred shares, particularly their priority claim on assets and earnings and their fixed dividend payments, can significantly impact a company's capital structure and financial flexibility. The priority claim of preferred shares means they are serviced before common shareholders, which can make a company's capital structure more debt-like and potentially reduce its financial flexibility. The fixed dividend payments of preferred shares also represent a contractual obligation, similar to interest payments on debt, which can limit a company's ability to adjust its cash flows in response to changing market conditions. However, the hybrid nature of preferred shares, being neither pure debt nor pure equity, can also provide companies with more financing options and potentially a lower cost of capital compared to traditional debt. Careful consideration of these trade-offs is necessary when evaluating preferred shares as an alternative source of funds.

Related terms

Cumulative Dividends: Preferred shares that have cumulative dividends require any unpaid or skipped dividends to be paid out before common shareholders can receive dividends.

Convertible Preferred Shares: Preferred shares that can be converted into a predetermined number of common shares, allowing shareholders to participate in the company's growth.

Callable Preferred Shares: Preferred shares that the issuing company has the right to redeem or buy back from shareholders at a predetermined price, typically after a specified period of time.