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Preference Share

In general there are two types of shares: 1. the preference share and 2. the ordinary share.

 

Preference or preferred shares grant the shareholder certain extra rights which shareholders owning ordinary stock do not have.

Holders of preference shares are paid first when the company pays dividends. Moreover the preferred shares, in most cases, come at a fixed rate payment. This means, no matter how the company performs, it is obligated to pay a fixed amount of dividends to the preference share holder every year.

This can be good in times when the ordinary dividend payment is low or not paid at all, but it can also be bad in times of good performance when the dividends for ordinary shares are higher.

 

Therefore preferred shares offer a high security, as the dividends are paid each year and at a fixed rate, independent from the companies performance. Much like a normal bond.

Moreover in case of bankruptcy preference shareholders are paid first.

On the contrary, ordinary shareholders MAY have a higher return, depending on the performance, but no security to be paid at all, if the company decides to not pay dividends.

 

 

Everything comes at a trade-off

Holding shares of a company makes you a partial owner of the company and thus you have a say or at least a vote in the company´s activity. This is not the case with preference shares. When having preference shares you do not have a vote at the general assembly or any other shareholder meetings.

Therefore a holder of preference shares is not entitled to vote for merger or elect the board of directors.

Ordinary shareholders do have the right to vote.

 

 

Breaking down different types of preferred shares

Cumulative preferred shares:

Here again, the holder is paid a fixed rate. But if the company announces to pay no dividends in a certain year, the holder can claim twice the amount in the next year. The payments cumulate over the periods.

 

Non-Cumulative preferred shares:

In this case, the holder cannot claim unpaid dividends in the next period. If the company chooses not to pay dividends, the holder has no right to compensation.

 

Participating preference share:

Combining ordinary and preferred shares: If the dividend of the ordinary share is higher, then the holder has a right to get an additional, equal to the amount of the ordinary share.

 

Convertible preference share:

In those cases preference shareholders have the option to convert preferred shares into ordinary shares. Usually this exchange can happen at any time. Yet a re-conversion is usually not allowed. The value of the conversion is based on the value of ordinary shares and therefore depends on company´s performance.