Preferred Stock
What is preferred stock?
Preferred stock are equity shares in a company, but they straddle the line between stocks and bonds. Stocks form the relative portion of ownership a person holds in a given company. Preferred stocks entitle their holders to dividend payments on their shares, although this must be approved by the company’s board of directors.
Our law offices specialize in company law. We help our corporate clients navigate the Israeli legal system.
Preferred stock versus common stock
The advantage of preferred over common stock is that the former entitles its owners to fixed dividend payments. Both are taxable to the shareholders and are only paid after the company has satisfied its tax requirements.
The income payments accruing to preferred stock owners are superior to common stocks and bonds. Investment per share is also lower than that for bonds. Perhaps most importantly, preferred shareholders are entitled to receive fixed dividends before common stockholders. A major difference between the two is that common stockholders have voting rights, whereas owners of preferred shares generally do not.
Preferred shares are more stable in price than common stock and their liquidity outpaces that of corporate bonds. Yet, when it comes to sharing in a company’s success, common stock outpaces preferred stock. Preferred stock may have less volatility than common stock and is attractive to institutional investors, but the flip side of the coin is a lower payoff on company success.
In the United States, institutions have a major incentive to invest in preferred stocks. This is because IRS rules allow U.S. institutions that pay corporate income tax to exclude 70% of their dividend income from their taxable income. This enticement is not open to individual investors.
Different types of preferred stocks
There are different types of preferred stocks and they grant their owners different rights.
Cumulative – These entitle their owners to receive dividends in arrears, ahead of any other dividends, should the company decide to withhold any portion of its dividends. Straight, or non-cumulative stocks are shares that lack this feature.
Callable and Convertible – The former entitles its owners to redeem their shares at a time and price fixed in the company’s prospectus. The latter entitles its owners to convert shares at a time and price fixed in the prospectus.
Participating – These are stocks which pay dividends at a fixed rate. Participating Preferred grant their owners the possibility of earning interest on their shares in excess of the fixed rate. The majority of preferred shares are non-participating.
Preferred stocks versus bonds
Preferred stocks are considered equity, while bonds have the status of debt. This has ramifications in the event that a company will need to pay off creditors. The latter have a senior claim to preferred stock owners, with common stockholders having the most junior claims. Like bonds, preferred shares are sensitive to the fluctuation of interest rates. However, preferred shares hold the advantage of being less sensitive to price fluctuations than bonds.
Preferred shares also have no fixed maturity date, although they may be called in after a certain date, a feature they share with bonds. This would be done so that the owner may receive a higher rate than that found in the current market value. So too, it is easier for potential owners of preferred shares to obtain information concerning them than it is for bonds. This makes preferred shares easier to trade. Both of these are rated by major credit companies, such as Moody’s and Standard & Poor. Since interest payments from bonds carry higher guarantees and are senior in payment than preferred share dividends, they tend to receive a higher rating.
We are available to answer any you may have about stocks or corporate law.
:
:מאמרים מומלצים