Preference shares, more commonly referred to as preferred stock, are shares of a company’s stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, the shareholders with preferred stock are entitled to be paid from company assets first. Most preference shares have a fixed dividend, while common stocks generally do not. Preferred stock shareholders also typically do not hold any voting rights, but common shareholders usually do.
BREAKING DOWN ‘Preference Shares’
There are four types of preference shares:
- Cumulative preferred stock includes a provision that requires the company to pay preferred shareholders all dividends, including those that were omitted in the past, before the common shareholders are able to receive their dividend payments.
- A non-cumulative preferred stock does not issue any omitted or unpaid dividends. If the company chooses not to pay dividends in any given year, the shareholders of the non-cumulative preferred stock have no right or power to claim such forgone dividends at any time in the future.
- Participating preferred stock provides its shareholders with the right to be paid dividends in an amount equal to the generally specified rate of preferred dividends plus an additional dividend based on a predetermined condition. This additional dividend is typically designed to be paid out only if a number of dividends received by common shareholders is greater than a predetermined per-share amount. If the company is liquidated, participating preferred shareholders may also have the right to be paid back the purchasing price of the stock as well as a pro-rata share of remaining proceeds received by common shareholders.
- Convertible preferred stock includes an option that allows shareholders to convert their preferred shares into a set number of common shares, generally any time after a pre-established date. Under normal circumstances, convertible preferred shares are exchanged in this way at the shareholder’s request. However, a company may have a provision on such shares that allows the shareholders or the issuer to force the issue. How valuable convertible common stocks are is based, ultimately, on how well the common stock performs.
Significance to Investors
Preference shares are an optimal alternative for risk-averse equity investors. Preference shares are typically less volatile than common shares and offer investors a steadier flow of dividends. Also, preference shares are usually callable; the issuer of the shares can redeem them at any time, providing investors with more options than common shares.