Callable stock definition
/What is Callable Stock?
Callable stock is shares in a company that the issuer can buy back. Callable stock may be issued in order to have the option of retaining tighter control over a business or to avoid paying interest on preferred stock. The issuer buys back the shares under the terms of an agreement that states the buy back price (known as the call price) and the dates or circumstances under which the issuer can buy back the shares. The term "callable stock" is almost always applied to preferred stock.
Preferred stock usually involves the payment of a predetermined amount of interest to the holders of the stock, such as 8% interest, to be paid at the end of each year. An issuer may not want to pay this interest in perpetuity, especially if the interest rate paid is substantially above the market interest rate. Therefore, it includes the callable stock feature in the stock agreement so that it can buy the stock back, thereby eliminating its obligation to continue paying the high interest rate. A typical call feature states that an issuer can buy back preferred stock at a specific price point, plus any accrued interest that the stockholder has earned since the last interest payment date.
Advantages of Callable Stock
There are several advantages to offering callable stock to investors, though all of these advantages are from the perspective of the issuer, not the investor. The advantages are as follows:
Retain control. The issuer may only repurchase stock from minority shareholders, thereby allowing its majority shareholders to retain tighter control over the entity.
Avoid paying interest. If preferred stock is callable and that stock pays interest or a dividend, then repurchasing this stock will reduce the payout obligation of the issuer.
Cap the stock price. The market price of a share is usually capped at the repurchase price, since investors know that they will only be paid this amount in the event of a repurchase event.
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Example of Callable Stock
ABC International issues preferred stock at $100 per share, with 8% interest. The stock agreement contains a call feature, under which ABC has the right, but not the obligation, to buy back the shares at any time after two years have passed, at a price of $120 plus any interest that has been accrued but not paid as of the buy back date.
A side effect of this example is that the market will not bid the price of the stock over $120, since a buyer could potentially lose the difference between $120 and any higher price paid to buy the stock if the company elects to trigger the buy back clause. Because of this built-in limitation on the price of preferred stock, investors tend to resist buying shares that contain the call feature. However, a company that is experiencing broad investor demand for its equity offerings may still be able to impose the feature.
The Right of First Refusal
A variation on the callable stock concept is the right of first refusal, under which a company has the right to meet any offer made to purchase the shares of a shareholder. By doing so, the business can reduce the number of shareholders, which concentrates voting rights with a smaller number of shareholders, and also reduces the risk that having an excessive number of shareholders will force the company to begin filing reports with the Securities and Exchange Commission as a public company.
Terms Similar to Callable Stock
Callable stock is also known as redeemable stock.