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Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of
share capital A corporation's share capital, commonly referred to as capital stock in the United States, is the portion of a corporation's equity that has been derived by the issue of shares in the corporation to a shareholder, usually for cash. "Share capital ...
that may have any combination of features not possessed by
common stock Common stock is a form of corporate equity ownership, a type of security. The terms voting share and ordinary share are also used frequently outside of the United States. They are known as equity shares or ordinary shares in the UK and other Comm ...
, including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. Preferred stocks are senior (i.e., higher ranking) to common stock but subordinate to bonds in terms of claim (or rights to their share of the assets of the company, given that such assets are payable to the returnee stock bond) and may have priority over common stock (ordinary shares) in the payment of dividends and upon
liquidation Liquidation is the process in accounting by which a company is brought to an end in Canada, United Kingdom, United States, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and property of the company are redistrib ...
. Terms of the preferred stock are described in the issuing company's
articles of association In corporate governance, a company's articles of association (AoA, called articles of incorporation in some jurisdictions) is a document which, along with the memorandum of association (in cases where it exists) form the company's constituti ...
or
articles of incorporation Article often refers to: * Article (grammar), a grammatical element used to indicate definiteness or indefiniteness * Article (publishing), a piece of nonfictional prose that is an independent part of a publication Article may also refer to: ...
. Like bonds, preferred stocks are rated by major credit rating agencies. Their ratings are generally lower than those of bonds, because preferred dividends do not carry the same guarantees as interest payments from bonds, and because preferred-stock holders' claims are junior to those of all creditors. Preferred equity has characteristics similar to preferred stock, but the term is typically used for investments in real estate or other private investments where the common stock is not publicly traded, so private equity has no public credit rating.


Features

Features usually associated with preferred stock include:. * Preference in
dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-i ...
s * Preference in assets, in the event of
liquidation Liquidation is the process in accounting by which a company is brought to an end in Canada, United Kingdom, United States, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and property of the company are redistrib ...
* Convertibility to common stock * Callability (ability to be redeemed before maturity) at the corporation's option (possibly subject to a spens clause) * Nonvoting * Higher dividend yields


Preference in dividends

In general, preferred stock has ''preference'' in dividend payments. The preference does not assure the payment of dividends, but the company must pay the stated dividends on preferred stock before or at the same time as any dividends on common stock. Preferred stock can be ''cumulative'' or ''noncumulative''. A cumulative preferred requires that if a company fails to pay a dividend (or pays less than the stated rate), it must make up for it at a later time in order to ever pay common-stock dividends again. Dividends accumulate with each passed dividend period (which may be quarterly, semi-annually or annually). When a dividend is not paid in time, it has "passed"; all passed dividends on a cumulative stock make up a dividend in arrears. A stock without this feature is known as a noncumulative, or ''straight'', preferred stock; any dividends passed are lost if not declared.


Other features or rights

* Preferred stock may or may not have a fixed
liquidation value Liquidation value is the likely price of an asset when it is allowed insufficient time to sell on the open market, thereby reducing its exposure to potential buyers. Liquidation value is typically lower than fair market value. Unlike cash or securi ...
(or
par value Par value, in finance and accounting, means stated value or face value. From this come the expressions at par (at the par value), over par (over par value) and under par (under par value). Bonds A bond selling at par is priced at 100% of face valu ...
) associated with it. This represents the amount of capital that was contributed to the corporation when the shares were first issued. * Preferred stock has a claim on
liquidation Liquidation is the process in accounting by which a company is brought to an end in Canada, United Kingdom, United States, Ireland, Australia, New Zealand, Italy, and many other countries. The assets and property of the company are redistrib ...
proceeds of a
stock corporation A joint-stock company is a business entity in which shares of the company's stock can be bought and sold by shareholders. Each shareholder owns company stock in proportion, evidenced by their shares (certificates of ownership). Shareholders a ...
equal to its par (or liquidation) value, unless otherwise negotiated. This claim is senior to that of common stock, which has only a residual claim. * Almost all preferred shares have a negotiated, fixed-dividend amount. The dividend is usually specified as a percentage of the par value or as a fixed amount (for example, Pacific Gas & Electric 6% Series A Preferred). Sometimes, dividends on preferred shares may be negotiated as ''floating''; they may change according to a benchmark interest-rate index (such as
LIBOR The London Inter-Bank Offered Rate is an interest-rate average calculated from estimates submitted by the leading banks in London. Each bank estimates what it would be charged were it to borrow from other banks. The resulting average rate is u ...
). * Some preferred shares have special voting
rights Rights are legal, social, or ethical principles of freedom or entitlement; that is, rights are the fundamental normative rules about what is allowed of people or owed to people according to some legal system, social convention, or ethical theory ...
to approve extraordinary events (such as the issuance of new
shares In financial markets, a share is a unit of equity ownership in the capital stock of a corporation, and can refer to units of mutual funds, limited partnerships, and real estate investment trusts. Share capital refers to all of the shares of ...
or approval of the acquisition of a company) or to elect directors, but most preferred shares have no voting rights associated with them; some preferred shares gain voting rights when the preferred dividends are in arrears for a substantial time. This is all variable on the rights assigned to the preferred shares at the time of incorporation. The above list (which includes several customary rights) is not comprehensive; preferred shares (like other legal arrangements) may specify nearly any right conceivable. Preferred shares in the U.S. normally carry a call provision, enabling the issuing corporation to repurchase the share at its (usually limited) discretion.


Types

In addition to straight preferred stock, there is diversity in the preferred stock market. Additional types of preferred stock include: * ''Prior preferred stock''—Many companies have different issues of preferred stock outstanding at one time; one issue is usually designated highest-priority. If the company has only enough money to meet the dividend schedule on one of the preferred issues, it makes the payments on the prior preferred. Therefore, prior preferreds have less credit risk than other preferred stocks (but usually offer a lower yield). * ''Preference preferred stock''—Ranked behind a company's prior preferred stock (on a seniority basis) are its preference preferred issues. These issues receive preference over all other classes of the company's preferred (except for prior preferred). If the company issues more than one issue of preference preferred, the issues are ranked by seniority. One issue is designated first preference, the next-senior issue is the second and so on. * ''Convertible preferred stock''—These are preferred issues that holders can exchange for a predetermined number of the company's common-stock shares. This exchange may occur at any time the investor chooses, regardless of the market price of the common stock. It is a one-way deal; one cannot convert the common stock back to preferred stock. A variant of this is the ''anti-dilutive convertible preferred'' recently made popular by investment banker Stan Medley who structured several variants of these preferred for some forty plus public companies. In the variants used by Stan Medley, the preferred share converts to either a percentage of the company's common shares or a fixed dollar amount of common shares rather than a set number of shares of common. The intention is to ameliorate the bad effects investors suffer from rampant shorting and dilutive efforts on the OTC markets. * ''Cumulative preferred stock''—If the dividend is not paid, it will accumulate for future payment. * ''Non-cumulative preferred stock''—Dividends for this type of preferred stock will not accumulate if they are unpaid; very common in TRuPS and bank preferred stock, since under BIS rules preferred stock must be non-cumulative if it is to be included in Tier 1 capital. * ''Exchangeable preferred stock''—This type of preferred stock carries an
embedded option An embedded option is a component of a financial bond or other security, which provides the bondholder or the issuer the right to take some action against the other party. There are several types of options that can be embedded into a bond; common ...
to be exchanged for some other security. * '' Participating preferred stock''—These preferred issues offer holders the opportunity to receive extra dividends if the company achieves predetermined financial goals. Investors who purchased these stocks receive their regular dividend regardless of company performance (assuming the company does well enough to make its annual dividend payments). If the company achieves predetermined sales, earnings or profitability goals, the investors receive an additional dividend. * ''Perpetual preferred stock''—This type of preferred stock has no fixed date on which invested capital will be returned to the shareholder (although there are redemption privileges held by the corporation); most preferred stock is issued without a redemption date. * ''Putable preferred stock''—These issues have a " put" privilege, whereby the holder may (under certain conditions) force the issuer to redeem shares. * '' Monthly income preferred stock''—A combination of preferred stock and subordinated debt.


Usage

Preferred stocks offer a company an alternative form of financing—for example through pension-led funding; in some cases, a company can defer dividends by going into arrears with little penalty or risk to its credit rating, however, such action could have a negative impact on the company meeting the terms of its financing contract. With traditional debt, payments are required; a missed payment would put the company in default. Occasionally, companies use preferred shares as means of preventing
hostile takeover In business, a takeover is the purchase of one company (the ''target'') by another (the ''acquirer'' or ''bidder''). In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to t ...
s, creating preferred shares with a poison pill (or forced-exchange or conversion features) that is exercised upon a change in control. Some corporations contain provisions in their charters authorizing the issuance of preferred stock whose terms and conditions may be determined by the board of directors when issued. These "blank checks" are often used as a takeover defense; they may be assigned very high liquidation value (which must be redeemed in the event of a change of control), or may have great super-voting powers. When a corporation goes bankrupt, there may be enough money to repay holders of preferred issues known as "
senior Senior (shortened as Sr.) means "the elder" in Latin and is often used as a suffix for the elder of two or more people in the same family with the same given name, usually a parent or grandparent. It may also refer to: * Senior (name), a surname ...
" but not enough money for " junior" issues. Therefore, when preferred shares are first issued, their governing document may contain protective provisions preventing the issuance of new preferred shares with a senior claim. Individual series of preferred shares may have a senior, pari-passu (equal), or junior relationship with other series issued by the same corporation.


Users

Preferred shares are more common in private or pre-public companies, where it is useful to distinguish between the control of and the economic interest in the company. Government regulations and the rules of stock exchanges may either encourage or discourage the issuance of publicly traded preferred shares. In many countries, banks are encouraged to issue preferred stock as a source of Tier 1 capital. A company may issue several classes of preferred stock. A company raising
venture capital Venture capital (often abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to startups, early-stage, and emerging companies that have been deemed to have high growth potential or which h ...
or other funding may undergo several rounds of financing, with each round receiving separate rights and having a separate class of preferred stock. Such a company might have "
Series A A series A round (also known as series A financing or series A investment) is the name typically given to a company's first significant round of venture capital financing. The name refers to the class of preferred stock sold to investors in exc ...
Preferred", " Series B Preferred", "Series C Preferred", and corresponding shares of common stock. Typically, company founders and employees receive common stock, while venture capital investors receive preferred shares, often with a liquidation preference. The preferred shares are typically converted to common shares with the completion of an
initial public offering An initial public offering (IPO) or stock launch is a public offering in which shares of a company are sold to institutional investors and usually also to retail (individual) investors. An IPO is typically underwritten by one or more investme ...
or acquisition. An additional advantage of issuing preferred shares to investors but common shares to employees is the ability to retain a lower 409(a) valuation for common shares and thus a lower strike price for
incentive stock option Incentive stock options (ISOs), are a type of employee stock option that can be granted only to employees and confer a U.S. tax benefit. ISOs are also sometimes referred to as statutory stock options by the IRS. ISOs have a strike price, which is ...
s. This allows employees to receive more gains on their stock. In the United States there are two types of preferred stocks: ''straight'' preferreds and ''convertible'' preferreds. Straight preferreds are issued in perpetuity (although some are subject to call by the issuer, under certain conditions) and pay a stipulated dividend rate to the holder. Convertible preferreds—in addition to the foregoing features of a straight preferred—contain a provision by which the holder may convert the preferred into the common stock of the company (or sometimes, into the common stock of an affiliated company) under certain conditions (among which may be the specification of a future date when conversion may begin, a certain number of common shares per preferred share, or a certain price per share for the common stock). There are income-tax advantages generally available to ''corporations'' investing in preferred stocks in the United States. See
Dividends received deduction The dividends-received deduction (or "DRD"), under U.S. federal income tax law, is a tax deduction received by a corporation on the dividends it receives from other corporations in which it has an ownership stake. Impact This deduction is designed ...
. But for ''individuals'', a ''straight'' preferred stock, a hybrid between a bond and a stock, bears some disadvantages of each type of securities without enjoying the advantages of either. Like a bond, a straight preferred does not participate in future earnings and dividend growth of the company, or growth in the price of the common stock. However, a bond has greater security than the preferred and has a maturity date at which the principal is to be repaid. Like the common, the preferred has less security protection than the bond. However, the potential increase in the market price of the common (and its dividends, paid from future growth of the company) is lacking for the preferred. One advantage of the preferred to its issuer is that the preferred receives better equity credit at rating agencies than straight debt (since it is usually perpetual). Also, certain types of preferred stock qualify as Tier 1 capital; this allows financial institutions to satisfy regulatory requirements without diluting common shareholders. Through preferred stock, financial institutions are able to gain leverage while receiving Tier 1 equity credit. If an investor paid par ($100) today for a typical straight preferred, such an investment would give a current yield of just over six percent. If, in a few years, 10-year Treasuries were to yield more than 13 percent to maturity (as they did in 1981) these preferreds would yield at least 13 percent; since the rate of dividend is fixed, this would reduce their market price to $46, a 54-percent loss. The difference between straight preferreds and Treasuries (or any investment-grade Federal-agency or corporate bond) is that the bonds would move up to par as their maturity date approaches; however, the straight preferred (having no maturity date) might remain at these $40 levels (or lower) for a long time. Advantages of straight preferreds may include higher yields and—in the U.S. at least—tax advantages; they yield about 2 percent more than 10-year Treasuries, rank ahead of common stock in case of bankruptcy and dividends are taxable at a maximum rate of 15% rather than at ordinary-income rates (as with bond interest).


Advantages of preference shares

# No obligation for dividends: A company is not bound to pay a dividend on preference shares if its profits in a particular year are insufficient. It can postpone the dividend in case of cumulative preference shares also. No fixed burden is created on its finances. # No interference: Generally, preference shares do not carry voting rights. Therefore, a company can raise capital without dilution of control. Equity shareholders retain exclusive control over the company. # Trading on equity: The rate of dividend on preference shares is fixed. Therefore, with the rise in its earnings, the company can provide the benefits of trading on equity to the equity shareholders. # No charge on assets: Preference shares do not create any mortgage or charge on the assets of the company. The company can keep its fixed assets free for raising loans in future # Variety: Different types of preference shares can be issued depending on the needs of investors. Participating preference shares or convertible preference shares may be issued to attract bold and enterprising investors.


Country-by-country perspectives


Canada

Preferred shares represent a significant portion of Canadian capital markets, with over C$11.2 billion in new preferred shares issued in 2016. Many Canadian issuers are financial organizations that may count capital raised in the preferred-share market as Tier 1 capital (provided that the shares issued are perpetual). Another class of issuer includes
split share corporation A split share corporation is a corporation that exists for a defined period of time to transform the risk and investment return ( capital gains, dividends, and possibly also profits from the writing of covered options) of a basket of shares of c ...
s. Investors in Canadian preferred shares are generally those who wish to hold fixed-income investments in a taxable portfolio. Preferential tax treatment of dividend income (as opposed to interest income) may, in many cases, result in a greater after-tax return than might be achieved with bonds. Preferred shares are often used by private corporations to achieve Canadian tax objectives. For instance, the use of preferred shares can allow a business to accomplish an estate freeze. By transferring common shares in exchange for fixed-value preferred shares, business owners can allow future gains in the value of the business to accrue to others (such as a discretionary trust).


Germany

The rights of holders of preference shares in Germany are usually rather similar to those of ordinary shares, except for some dividend preference and no voting right in many topics of shareholders' meetings. Preference shares in German stock exchanges are usually indicated with ''V'', ''VA'', or ''Vz'' (short for ')—for example, "BMW Vz"—in contrast to ''St'', ''StA'' (short for '), or ''NA'' (short for ') for standard shares. Preference shares with multiple voting rights (e.g., at RWE or
Siemens Siemens AG ( ) is a German multinational conglomerate corporation and the largest industrial manufacturing company in Europe headquartered in Munich with branch offices abroad. The principal divisions of the corporation are ''Industry'', ''E ...
) have been abolished. Preferred stock may comprise up to half of total equity. It is convertible into common stock, but its conversion requires approval by a majority vote at the stockholders' meeting. If the vote passes, German law requires consensus with preferred stockholders to convert their stock (which is usually encouraged by offering a one-time premium to preferred stockholders). The firm's intention to do so may arise from its financial policy (i.e. its ranking in a specific index). Industry stock indices usually do not consider preferred stock in determining the daily trading volume of a company's stock; for example, they do not qualify the company for a listing due to a low trading volume in common stocks.


United Kingdom

Perpetual non-cumulative preference shares may be included as Tier 1 capital. Perpetual cumulative preferred shares are Upper Tier 2 capital. Dated preferred shares (normally having an original maturity of at least five years) may be included in Lower Tier 2 capital.


United States

In the United States, the issuance of publicly listed preferred stock is generally limited to financial institutions,
REIT A real estate investment trust (REIT) is a company that owns, and in most cases operates, income-producing real estate. REITs own many types of commercial real estate, including office and apartment buildings, warehouses, hospitals, shopping c ...
s and public utilities. Because in the U.S. dividends on preferred stock are not tax-deductible at the corporate level (in contrast to interest expense), the effective cost of capital raised by preferred stock is significantly greater than issuing the equivalent amount of debt at the same interest rate. This has led to the development of TRuPS: debt instruments with the same properties as preferred stock. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, TRuPS will be phased out as a vehicle for raising Tier 1 capital by bank
holding companies A holding company is a company whose primary business is holding a controlling interest in the securities of other companies. A holding company usually does not produce goods or services itself. Its purpose is to own shares of other companies ...
. Outstanding TRuPS issues will be phased out completely by 2015. However, with a qualified dividend tax rate of 23.8% (compared to a top ordinary interest marginal tax rate of 40.8%), $1 of dividend income taxed at this rate provides the same after-tax income as approximately $1.30 in interest income. The size of the preferred stock market in the United States has been estimated as $100 billion (), compared to $9.5 trillion for equities and US$4.0 trillion for bonds. The amount of new issuance in the United States was $34.1 billion in 2016.


Other countries

* In
Nigeria Nigeria ( ), , ig, Naìjíríyà, yo, Nàìjíríà, pcm, Naijá , ff, Naajeeriya, kcg, Naijeriya officially the Federal Republic of Nigeria, is a country in West Africa. It is situated between the Sahel to the north and the Gulf o ...
, preferred shares make up a small percentage of a company's stock with no voting rights except in cases where they are not paid dividends; owners of preferred shares are entitled to a greater percentage of company profits. * ''Czech Republic''—Preferred stock cannot be more than 50 percent of total equity. * ''
France France (), officially the French Republic ( ), is a country primarily located in Western Europe. It also comprises of Overseas France, overseas regions and territories in the Americas and the Atlantic Ocean, Atlantic, Pacific Ocean, Pac ...
''—By a law enacted in June 2004, France allows the creation of preferred shares. * ''
South Africa South Africa, officially the Republic of South Africa (RSA), is the southernmost country in Africa. It is bounded to the south by of coastline that stretch along the South Atlantic and Indian Oceans; to the north by the neighbouring coun ...
''—Dividends from preference shares are not taxable as income when held by individuals. * ''
Brazil Brazil ( pt, Brasil; ), officially the Federative Republic of Brazil (Portuguese: ), is the largest country in both South America and Latin America. At and with over 217 million people, Brazil is the world's fifth-largest country by area ...
''—In Brazil, up to 50 percent of the capital stock of a company may be composed of preferred stock. The preferred stock will have at least one less right than the common stock (normally voting power), but will have a preference in receiving dividends. * ''Russia''—No more than 25% of capital may be preferred stock. Voting rights are limited, but if dividends are not fully paid, shareholders obtain full voting rights.


Notes


External links


"The Many Flavors of Preferred Stock"
at About.com {{DEFAULTSORT:Preferred Stock Corporate finance Equity securities Stock market Embedded options pl:Akcja niema