Types of preference shares
/What are the Types of Preference Shares?
Preference shares are shares in the equity of a company that entitle the holder to a fixed dividend amount to be paid by the issuer. This dividend must be paid before the company can issue any dividends to its common shareholders. Also, if the company is dissolved, the owners of preference shares are paid back before the holders of common stock, which can be a key advantage in the event of a bankruptcy. However, the holders of preference shares do not usually have any voting control over the affairs of the company, as do the holders of common stock. The types of preference shares are noted below.
Callable Preference Shares
With callable preference shares, the issuing company has the right to buy back these shares at a certain price on a certain date. Since the call option tends to cap the maximum price to which a preference share can appreciate (before the company buys it back), it tends to restrict stock price appreciation.
From the perspective of the issuer, there are several advantages to issuing callable preference shares. They are as follows:
More flexible capital structure. The issuer has the option to buy back these shares, allowing it to shift the proportions of equity and debt in its capital structure.
Cost-effectiveness. The issuer can potentially buy back shares at a relatively low price, depending on the terms associated with the issuance.
Use for excess cash. The issuer can buy back shares when it has excess cash available to do so, and is under no obligation to buy back shares when it does not have any excess cash on hand.
Convertible Preference Shares
With convertible preferred stock, the owner of these preference shares has the option, but not the obligation, to convert the shares to a company's common stock at some conversion ratio. This is a valuable feature when the market price of the common stock increases substantially, since the owners of preference shares can realize substantial gains by converting their shares.
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Cumulative Preference Shares
With cumulative preference shares, if a company does not have the financial resources to pay a dividend to the owners of its preference shares, then it still has the payment liability, and cannot pay dividends to its common shareholders for as long as that liability remains unpaid. When there is a payment liability, these dividends are referred to as dividends in arrears.
Non-Cumulative Preference Shares
With non-cumulative preference shares, if a company does not pay a scheduled dividend, it does not have the obligation to pay the dividend at a later date. This clause is rarely used, since it is not attractive to prospective investors.
Participating Preference Shares
With participating preference shares, the issuing company must pay an increased dividend to the owners of preference shares if there is a participation clause in the share agreement. This clause states that a certain portion of earnings (or of the dividends issued to the owners of common stock) will be distributed to the owners of preferences shares in the form of dividends. These shares also have a fixed dividend rate. This feature makes participating preference shares more attractive to investors, who may accordingly bid up their price.
Treatment of Preference Shares in a Bankruptcy
If the issuer of preference shares enters bankruptcy proceedings, then the holders of its preference shares will have a claim on the firm’s assets that is junior to its secured creditors (such as the holders of its bonds), but senior to the holders of its common stock. If the net asset balance of the issuer is relatively small at the time of its bankruptcy, it is quite possible that the holders of its preference shares will receive nothing, since they are relatively low in the priority of bankruptcy payouts.
Terms Similar to Preference Shares
Preference shares are the same as preferred stock. The term "preference shares" is more commonly used in Europe.
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