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Preference Shares: Types, Benefits, and Key Characteristics

Last updated 03/15/2024 by

Alessandra Nicole

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Preference shares, commonly known as preferred stock, offer investors priority dividend payments over common stockholders and hold specific characteristics that distinguish them from common shares. This article provides an in-depth exploration of preference shares, outlining their types, characteristics, and implications for investors.

Understanding preference shares

Overview of preference shares

Preference shares, or preferred stock, represent a class of ownership in a corporation with priority rights to dividends and assets compared to common shares. Investors opt for preference shares due to their preference in receiving dividends before common shareholders. However, they often lack voting rights associated with common shares.

Types of preference shares

Cumulative preferred stock

Cumulative preferred stock ensures that any missed dividend payments accumulate and must be paid before common shareholders receive dividends. These accumulated dividends are known as “dividends in arrears” and are typically paid to the current shareholder when distributions occur.

Non-cumulative preferred stock

Non-cumulative preferred stock does not accumulate or owe past dividends. If a company doesn’t pay dividends in a particular period, shareholders have no claim or right to these dividends in the future.

Participating preferred stock

Participating preferred stock grants additional dividends, based on a predetermined condition, beyond the fixed preferred dividend. This extra dividend is typically paid only if common shareholders receive dividends surpassing a specified per-share amount. In a liquidation event, participating preferred shareholders might also receive their stock’s purchase price and a share of remaining proceeds.

Convertible preferred stock

Convertible preferred stock permits shareholders to exchange their preferred shares for a set number of common shares after a specified date. The value of convertible preferred stock relies on the performance of the associated common shares and may involve an option for the issuer or shareholders to force the conversion.

Key characteristics of preference shares

Preference shares offer a blend of characteristics from both common stock and fixed-income securities. They grant priority for dividend payments but typically lack voting rights comparable to common stock. Four key types of preference shares determine payment characteristics: cumulative, non-cumulative, participating, and convertible.
Here is a list of the benefits and the drawbacks to consider.
  • Priority in dividend payments
  • Less volatile than common stocks
  • Option for conversion to common shares
  • Limited or no voting rights
  • Lower potential for high returns compared to common shares
  • Risk of call options on convertible preferred stocks

Frequently asked questions

What are preference shares?

Preference shares, also known as preferred shares, are a type of security providing shareholders with priority in receiving dividends and assets over common shareholders.

What are the main types of preference shares?

There are four main types: cumulative preferred, non-cumulative preferred, participating preferred, and convertible. Each type offers distinct features in dividend payment and conversion options.

What happens if you own preference shares in a bankrupt company?

In the case of bankruptcy, preference shareholders are typically given priority over common shareholders for assets, but they rank lower than bondholders or other fixed-income security holders.

Key takeaways

  • Preference shares grant priority in dividend payments over common stock.
  • There are four main types: cumulative, non-cumulative, participating, and convertible preferred stock.
  • Convertible preferred stock allows conversion to common shares.

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