Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument. Preferreds are senior (i.e. higher ranking) to common stock Common stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc. On the other hand, common shares on average perform better than, but are subordinate to bonds In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals.^[1]

Preferred stock usually carries no voting rights,^[2] but may carry priority over common stock Common stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc. On the other hand, common shares on average perform better than in the payment of dividends and upon liquidation In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation. The process of liquidation also arises when customs, an authority or. Preferred stock may carry a dividend Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be paid to the shareholders as a dividend. Many corporations retain a that is paid out prior to any dividends being paid to common stock holders. Preferred stock may have a convertibility feature into common stock. Terms of the preferred stock are stated in a "Certificate of Designation".

Similar to bonds, preferred stocks are rated by the major credit rating companies. The rating for preferreds is generally lower since preferred dividends do not carry the same guarantees as interest payments from bonds and they are junior to all creditors.^[3]

Features

Preferred stock is a special class of shares that may have any combination of features not possessed by common stock.

The following features are usually associated with preferred stock^[4]

• Preference in dividends Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be paid to the shareholders as a dividend. Many corporations retain a.
• Preference in assets in the event of liquidation In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation. The process of liquidation also arises when customs, an authority or.
• Convertible into common stock.
• Callable at the option of the corporation.
• Nonvoting.

In general, preferreds have preference to dividends payments. A preference does not assure the payment of dividends, but the company must pay the stated dividend rate prior to paying any dividends on common stock.^[4]

Preferred stock can either be cumulative or noncumulative. A cumulative preferred stock requires that if a company fails to pay any dividend or any amount below the stated rate, it must make up for it at a later time. Dividends accumulate with each passed dividend period, which can be quarterly, semi-annually, or annually. When a dividend is not paid in time it is said that the dividend has "passed" and all passed dividends on a cumulative stock is a dividend in arrears Arrears is a legal term for the part of a debt that is overdue after missing one or more required payments. The amount of the arrears is the amount accrued from the date on which the first missed payment was due; the account is said to be "in arrears". The term is usually used in relation with periodically recurring payments such as rent,. A stock that doesn't have this feature is known as a noncumulative or straight^[5] preferred stock and any dividends passed are lost forever if not declared.^[6]

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 securities, certain illiquid assets, like real estate, often require a period of several months in order to, or par value Par value, in finance and accounting, means stated value or face value. From this comes the expressions at par , over par (over par value) and under par (under par value), associated with it. This represents the amount of capital that was contributed to the corporation when the shares were first issued.^[7]
• Preferred stock has a claim on liquidation In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation. The process of liquidation also arises when customs, an authority or proceeds of a stock corporation A stock corporation is a for-profit corporation which the ownership of the corporation is expressed by shares of stock. This allows for the ownership of the corporation to be readily determined, as shares are property, and are transferrable as any other property such as money, subject to any conditions imposed such as restriction on resale. The, equivalent 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 Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be paid to the shareholders as a dividend. Many corporations retain a 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 i.e. may change according to a benchmark interest rate index such as LIBOR The London Interbank Offered Rate is a daily reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank market).
• Some preferred shares have special voting rights Rights are legal, social, or ethical principles of freedom or entitlement — i.e. rights are normative rules about what is allowed of people or owed to people, according to some legal system, social convention, or ethical theory. The concept of rights is often fundamental to civilized societies, and it is of vital importance in such disciplines to approve certain extraordinary events (such as the issuance of new shares In financial markets, a share is a unit of account for various financial instruments including stocks , and investments in limited partnerships, and REITs. The common feature of all these is equity participation (limited in the case of preference shares) or the approval of the acquisition of the company) or to elect directors, but most preferred shares provide no voting rights associated with them. Some preferred shares only gain voting rights when the preferred dividends are in arrears for a substantial time.

The above list, although including several customary rights, is far from comprehensive. Preferred shares, like other legal arrangements, may specify nearly any right conceivable. Preferred shares in the U.S. normally carry a call provision,^[8] enabling the issuing corporation to repurchase the share at its (usually limited) discretion.

Types of preferred stock

In addition to the straight preferred, as just described, there is great 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 the same time and one of them is usually designated to be the one with the highest priority. If the company has only enough money to meet the dividend schedule on one of the preferred issues, it makes the dividend payments on the prior preferred. Therefore, prior preferred have less credit risk than the other preferred stocks but it usually offers a lower yield than the others.

• Preference Preferred Stock – Ranked behind the company's prior preferred stock (on a seniority basis), are the company's preference preferred issues. These issues receive preference over all other classes of the company's preferred except for the prior preferred. If the company issues more than one issue of preference preferred, then the various issues are ranked by their relative 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 the holders can exchange for a predetermined number of the company's common stock. This exchange can occur at any time the investor chooses regardless of the current market price of the common stock. It is a one way deal so one cannot convert the common stock back to preferred stock.

• Cumulative preferred stock – If the dividend is not paid, it will accumulate for future payment.

• Exchangeable preferred stock – This type of preferred stock carries the option to be exchanged for some other security upon certain conditions.

• Participating Preferred Stock Participating preferred stock is capital stock which provides a specific dividend that is paid before any dividends are paid to common stock holders, and which takes precedence over common stock in the event of a liquidation. This form of financing is used by private equity investors and venture capital firms. Holders of participating preferred – These preferred issues offer the holders the opportunity to receive extra dividends if the company achieves some predetermined financial goals. The investors who purchased these stocks receive their regular dividend regardless of how well or how poorly the company performs, assuming the company does well enough to make the 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 will always be redemption privileges held by the corporation. Most preferred stock is issued without a set redemption date.

• Putable preferred stock – These issues have a "put A put option is a financial contract between two parties, the writer (seller) and the buyer of the option. The buyer acquires a short position with the right, but not the obligation, to sell the underlying instrument at an agreed-upon price (the strike price). If the buyer exercises his right to sell the option, the seller is obliged to buy it at" privilege whereby the holder may, upon certain conditions, force the issuer to redeem shares.

• Monthly income preferred stock – A combination of preferred stock and subordinated debt In finance, subordinated debt is debt which ranks after other debts should a company fall into receivership or be closed.

• Non-cumulative preferred stock – Dividend for this type of preferred stock will not accumulate if it is unpaid. Very common in TRuPS and bank preferred stock, since under BIS The Bank for International Settlements is an international organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks." It is not accountable to any national government. The BIS carries out its work through subcommittees, the secretariats it hosts, and through its rules, preferred stock must be non-cumulative if it is to be included in Tier 1 capital Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view. It is composed of core capital, which consists primarily of common stock and disclosed reserves , but may also include non-redeemable non-cumulative preferred stock.^[9]

Typical usage

Preferred stocks offer a company an attractive alternative to financing. In most cases, a company can defer dividends by going into arrears without much of a penalty or risk to their credit rating.^[10] With traditional debt, payments are required and a missed payment would put the company in default.

Occasionally companies use preferred shares as means of preventing hostile takeovers In business, a takeover is the purchase of one company 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 the acquisition of a private company, creating preferred shares with a poison pill Poison pill is a term referring to any strategy, generally in business or politics, to increase the likelihood of negative results over positive ones for a party that attempts any kind of takeover. It derives from its original meaning of a literal poison pill carried by various spies throughout history, taken when discovered to eliminate the or forced exchange or conversion features that exercise 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 takeover defense (see also poison pill Poison pill is a term referring to any strategy, generally in business or politics, to increase the likelihood of negative results over positive ones for a party that attempts any kind of takeover. It derives from its original meaning of a literal poison pill carried by various spies throughout history, taken when discovered to eliminate the). These shares may be assigned very high liquidation value that must be redeemed Redemption value is the price at which the issuing company may choose to repurchase a security before its maturity date in the event of a change of control or may have enormous supervoting powers.

Sometimes preferred shares can contain protective provisions which prevent the issuance of new preferred shares with a senior claim. Individual series of preferred shares may have a senior, pari-passu In law, this term is commonly used as legal jargon. Black's Law Dictionary defines pari passu as "proportionally; at an equal pace; without preference." or junior relationship with other series issued by the same corporation A corporation is an institution that is granted a charter recognizing it as a separate legal entity having its own privileges, and liabilities distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business.

Users

Preferred shares are more common in private or pre-public companies, where it is more useful to distinguish between the control of and the economic interest in the company. Government regulations and the rules of stock exchanges may discourage or encourage the issuance of publicly traded preferred shares. In many countries banks Banking is generally a highly regulated industry, and government restrictions on financial activities by banks have varied over time and location. The current set of global bank capital standards are called Basel II. In some countries such as Germany, banks have historically owned major stakes in industrial corporations while in other countries are encouraged to issue preferred stock as a source of Tier 1 capital Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view. It is composed of core capital, which consists primarily of common stock and disclosed reserves , but may also include non-redeemable non-cumulative preferred stock. On the other hand, the Tel Aviv Stock Exchange The Tel Aviv Stock Exchange in Tel Aviv is Israel's only stock exchange prohibits listed companies from having more than one class of capital stock.^{[citation needed]}

A single company may issue several classes of preferred stock. For example, a company 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 common 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 the stipulated rate of interest 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.

There are income tax advantages generally available to corporations that invest in preferred stocks in the United States that are not available to individuals.

Some argue that a straight preferred stock, being a hybrid between a bond and a stock, bears the disadvantages of each of those types of securities without enjoying the advantages of either. Like a bond, a straight preferred does not participate in any future earnings and dividend growth of the company and any resulting growth of the price of the common. But the 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. But the potential of increases of market price of the common and its dividends paid from future growth of the company is lacking for the preferred. One big advantage that the preferred provides its issuer is that the preferred gets better equity credit at rating agencies than straight debt, since it is usually perpetual. Also, as pointed out above, certain types of preferred stock qualifies as Tier 1 capital. This allows financial institutions to satisfy regulatory requirements without diluting common shareholders. Said another way, through preferred stock, financial institutions are able to put on leverage while getting Tier 1 equity credit.

Suppose that an investor paid par ($100) today for a typical straight preferred. Such an investment would give a current yield of just over 6%. Now suppose that in a few years 10-year Treasuries were to yield 13+% to maturity, as they did in 1981; these preferreds would yield at least 13%, which would knock their market price down to $46, for a 54% loss. The important 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 is approached, whereas the straight preferred, having no maturity date, might remain at these $40 levels (or lower) for a very long time.

Advantages of straight preferreds posited by some advisers include higher yields and tax advantages (currently yield some 2% more than 10-year Treasuries, rank ahead of common stock in the case of bankruptcy, dividends are taxable at a maximum 15% rather than at ordinary income rates, as in the case of bond interest).

International perspectives

Canada

Preferred shares represent a significant portion of Canadian capital markets, with over CAD 5-billion in new preferred shares issued in 2005.[2]

Many Canadian issuers are financial organizations that may count capital raised in the preferred share market as Tier 1 capital Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view. It is composed of core capital, which consists primarily of common stock and disclosed reserves , but may also include non-redeemable non-cumulative preferred stock, provided that the shares issued are perpetual. Another class of issuer are "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 In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals.

Germany

Preference shares in German stock exchanges is usually indicated with V, VA or Vz, short for Vorzugsaktie, for example "BMW Vz",^[11] in contrast to St or StA, short for Stammaktie for standard shares.^[12]

Preferred stock may amount to up to half of the total equity. Preferred stock is convertible into common stock, but conversion needs approval by majority vote in the stockholders' meeting. If the vote passes, German law requires consensus with preferred stock holders to convert their stock, which is usually encouraged by offering a one-time premium to preferred stock holders. The firm's intention to do so may arise from its finance policy i.e. ranking in a specific index. Industry stock exchange indices usually do not consider preferred stock in determining daily trading volume of a company's stock e.g. do not qualify the company for a listing due to the low trading volume in (just common) stocks.

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