Preferred stock

Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component
of share capital that may have any combination of features not possessed by common stock, 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)[1] and may have priority over common stock (ordinary shares) in the payment of dividends and
upon liquidation. Terms of the preferred stock are described in the issuing company's articles of association
or articles of incorporation.

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[2][3] or other private investments where the common stock is not publicly traded, so private
equity has no public credit rating.[4]

Contents
Features
Preference in dividends
Other features or rights
Types
Usage
Users
Advantages of preference shares
Country-by-country perspectives
Canada
Germany
United Kingdom
United States
Other countries
Notes
External links

Features
Features usually associated with preferred stock include:[5]

Preference in dividends
 Preference in assets, in the event of liquidation
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.[5]

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,[6] preferred stock; any dividends passed are lost if not declared.[7]

Other features or rights

Preferred stock may or may not have a fixed liquidation value (or par value) associated with
it. This represents the amount of capital that was contributed to the corporation when the
shares were first issued.[8]
Preferred stock has a claim on liquidation proceeds of a stock corporation 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).
Some preferred shares have special voting rights to approve extraordinary events (such as
the issuance of new shares 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,[9] 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.[10] 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.
Exchangeable preferred stock—This type of preferred stock carries an embedded option 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.
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.[11]

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.[12] 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 takeovers, 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" 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 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 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 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 options. This allows employees to receive more gains on their
stock.[13]

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.

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

1. 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.
2. 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.
3. 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.
4. 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
5. 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.[14] 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 corporations. 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
Vorzugsaktie)—for example, "BMW Vz"[15]—in contrast to St, StA (short for Stammaktie), or NA (short
for Namensaktie) for standard shares.[16] Preference shares with multiple voting rights (e.g., at RWE or
Siemens) 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.[16]

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.[17]

United States

In the United States, the issuance of publicly listed preferred stock is generally limited to financial
institutions, REITs 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. Outstanding TRuPS
issues will be phased out completely by 2015.[18]

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.[19] The size of the preferred stock market in the United States has been estimated
as $100 billion (as of early 2008), compared to $9.5 trillion for equities and US$4.0 trillion for bonds.[20]
The amount of new issuance in the United States was $34.1 billion in 2016.[21]

Other countries
In Nigeria, 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—By a law enacted in June 2004, France allows the creation of preferred shares.
South Africa—Dividends from preference shares are not taxable as income when held by
individuals.
Brazil—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.[22]

Notes
1. Drinkard, T., A Primer On Preferred Stocks,
2. "Preferred Equity vs Common Equity: What's the Difference?" (https://leverage.com/financin
g/preferred-equity-vs-common-equity/). leverage.com. 2021-06-15. Retrieved 2022-06-07.
3. Moussa, Feras. "Taking a Closer Look at Preferred Equity and Why It's So Powerful in Real
Estate" (https://www.entrepreneur.com/article/414283). Entrepreneur. Retrieved 2022-06-07.
4. Zilber, Ariel (2022-06-07). "Elon Musk's threat to nix $44B Twitter deal reportedly halts
financing" (https://nypost.com/2022/06/07/elon-musks-threat-to-nix-44b-twitter-deal-reportedl
y-halts-financing/). New York Post. Retrieved 2022-06-07.
5. Kieso, Donald E.; Weygandt, Jerry J. & Warfield, Terry D. (2007), Intermediate Accounting
(12th ed.), New York: John Wiley & Sons, p. 738, ISBN 978-0-471-74955-4.
6. Drinkard T.
7. Kieso, Weygandt & Warfield 2007, p. 739.
8. Harvard Business Services, Inc. (https://www.delawareinc.com/101/index.cfm?pageid=1007
1) Archived (https://web.archive.org/web/20070203135621/http://www.delawareinc.com/101/
index.cfm?pageid=10071) 2007-02-03 at the Wayback Machine Accessed February 23,
2007
9. According to a Quantum Online table (http://www.quantumonline.com/pfdtable.cfm?Type=All
IncSec&SortColumn=Company&SortOrder=ASC) Archived (http://arquivo.pt/wayback/20160
523011939/http://www.quantumonline.com/pfdtable.cfm?Type=AllIncSec&SortColumn=Co
mpany&SortOrder=ASC) 2016-05-23 at the Portuguese Web Archive
10. "Corporate Restructuring – The New Solution For Capital Raises and Survivability – Artfield
Investments RD, Inc" (http://artfieldinvestmentsrdinc.info/blog/corporate-restructuring/).
artfieldinvestmentsrdinc.info. Archived (http://archive.wikiwix.com/cache/20130312184941/h
ttp://artfieldinvestmentsrdinc.info/blog/corporate-restructuring/) from the original on 12 March
2013. Retrieved 29 April 2018.
11. Basel Committee on Banking Supervision [Minimum Capital Requirements "Archived copy"
(http://www.bis.org/publ/bcbs128b.pdf) (PDF). Archived (https://web.archive.org/web/201202
19001037/http://www.bis.org/publ/bcbs128b.pdf) (PDF) from the original on 2012-02-19.
Retrieved 2012-02-21.] Accessed 2007-1-12
12. Heinkel, R. & Zechner, J. (1990), "The Role of Debt and Preferred Stock as a Solution to
Adverse Investment Incentives", Journal of Financial and Quantitative Analysis, 25 (1): 1–24
[p. 2], doi:10.2307/2330885 (https://doi.org/10.2307%2F2330885), JSTOR 2330885 (https://
www.jstor.org/stable/2330885).
13. Cohan, William D. (2017-03-08). "Valuation Shell Game: Silicon Valley's Dirty Secret" (http
s://www.nytimes.com/2017/03/08/business/dealbook/valuation-shell-game-silicon-valleys-di
rty-secret.html). The New York Times. ISSN 0362-4331 (https://www.worldcat.org/issn/0362-
4331). Retrieved 2019-09-10.
14. PreferredStockMarket.com (http://www.preferredstockmarket.com/primary-market-issuance-c
anada/) Archived (https://web.archive.org/web/20180429154632/http://www.preferredstockm
arket.com/primary-market-issuance-canada/) 2018-04-29 at the Wayback Machine
15. "eurex circular 036/07" (http://www.eurexchange.com/blob/125420/f9873a28167db74d21f45
0479892019a/data/cfni0362007e.pdf) (PDF). Frankfurt: Eurex Deutschland. 2007-02-27.
p. 1. Archived (https://web.archive.org/web/20170811011104/http://www.eurexchange.com/b
lob/125420/f9873a28167db74d21f450479892019a/data/cfni0362007e.pdf) (PDF) from the
original on 11 August 2017. Retrieved 6 May 2010.
16. "Stammaktie, Vorzugsaktie, Inhaberaktie, Namensakti Die Arten von Aktien" (http://www.wert
papier-forum.de/topic/798-stammaktie-vorzugsaktie-inhaberaktie-namensakti/) (in German).
2004-03-24. Archived (https://web.archive.org/web/20100816040934/http://www.wertpapier-f
orum.de/topic/798-stammaktie-vorzugsaktie-inhaberaktie-namensakti/) from the original on
16 August 2010. Retrieved 6 May 2010.
17. FSA Handbook, PRU 2.2 Capital resources (http://fsahandbook.info/FSA/html/handbook/PR
U/2/2) Archived (https://web.archive.org/web/20090223182350/http://fsahandbook.info/FSA/
html/handbook/PRU/2/2) 2009-02-23 at the Wayback Machine Accessed July 31, 2006
18. "Dividend Investing - Best Dividend Paying Stocks" (http://www.dividendinvestor.com).
DividendInvestor.com. Archived (https://web.archive.org/web/20150825135600/http://www.di
videndyieldhunter.com/) from the original on 25 August 2015. Retrieved 29 April 2018.
19. "How are capital gains taxed?" (https://www.taxpolicycenter.org/briefing-book/how-are-capit
al-gains-taxed). Tax Policy Center. 2019-08-01. Archived (https://web.archive.org/web/2019
0801195849/https://www.taxpolicycenter.org/briefing-book/how-are-capital-gains-taxed) from
the original on 2019-08-01. Retrieved 2019-09-10.
20. Standard & Poor's "Archived copy" (http://www2.standardandpoors.com/spf/pdf/index/Preferr
ed_Stock_Primer_2009.pdf?vregion=us&vlang=en) (PDF). Archived (https://web.archive.or
g/web/20110613194357/http://www2.standardandpoors.com/spf/pdf/index/Preferred_Stock_
Primer_2009.pdf?vregion=us&vlang=en) (PDF) from the original on 2011-06-13. Retrieved
2009-08-27. 2009-08-27
21. PreferredStockMarket.com (http://www.preferredstockmarket.com/primary-market-issuance-u
-s-market/) Archived (https://web.archive.org/web/20161229032836/http://www.preferredstoc
kmarket.com/primary-market-issuance-u-s-market/) 2016-12-29 at the Wayback Machine
22. "Федеральный закон "Об акционерных обществах" от 26.12.1995 N 208-ФЗ (последняя
редакция) / КонсультантПлюс" (http://www.consultant.ru/document/cons_doc_LAW_8743/).
www.consultant.ru. Archived (https://web.archive.org/web/20170913184843/http://www.cons
ultant.ru/document/cons_doc_law_8743/) from the original on 13 September 2017.
Retrieved 29 April 2018.

External links
"The Many Flavors of Preferred Stock" (http://beginnersinvest.about.com/cs/newinvestors/a/
091602a.htm) at About.com

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