Preferred Stock

Definition

Preferred stock is a type of equity security that gives the holder a higher claim on the company\'s assets and earnings compared to common stock. It typically offers a fixed dividend and has priority over common stock in the event of a liquidation.

5 Must Know Facts For Your Next Test

1. Preferred stock typically has a higher dividend rate than common stock, providing a more stable and predictable income stream for investors.
2. Preferred stockholders generally do not have voting rights, unlike common stockholders, but they have a higher claim on the company\'s assets and earnings.
3. Preferred stock can be convertible, meaning it can be exchanged for a predetermined number of common shares, allowing investors to participate in the company\'s growth.
4. Preferred stock can be callable, meaning the company can redeem the shares at a predetermined price, providing the company with more financial flexibility.
5. The issuance of preferred stock can be a way for a company to raise capital without diluting the voting rights of common stockholders.

Review Questions

• Explain the key differences between preferred stock and common stock in terms of their rights and claims on a company\'s assets and earnings.
  • The primary differences between preferred stock and common stock lie in their claims on a company\'s assets and earnings. Preferred stock typically has a higher dividend rate and a higher claim on the company\'s assets in the event of liquidation, compared to common stock. Preferred stockholders generally do not have voting rights, unlike common stockholders, but they have a priority claim on the company\'s earnings and assets. This means that preferred stockholders must be paid their dividends and receive their liquidation preference before common stockholders can receive any payments.
• Describe the potential benefits and drawbacks of a company issuing preferred stock as a means of raising capital.
  • Issuing preferred stock can provide several benefits for a company. It allows the company to raise capital without diluting the voting rights of common stockholders, as preferred stockholders typically do not have voting rights. Preferred stock also offers a more stable and predictable income stream for investors through its fixed dividend payments. However, there are also potential drawbacks. The fixed dividend payments on preferred stock can be a financial burden for the company, especially during economic downturns. Additionally, the higher claim on assets and earnings held by preferred stockholders may limit the company\'s financial flexibility and the potential upside for common stockholders.
• Analyze how the characteristics of preferred stock, such as convertibility and callability, can impact the investment decisions of both the company and the investors.
  • The characteristics of preferred stock, such as convertibility and callability, can significantly impact the investment decisions of both the company and the investors. Convertible preferred stock allows investors to exchange their shares for a predetermined number of common shares, enabling them to participate in the company\'s growth. This feature can make preferred stock more attractive to investors, as it provides the potential for capital appreciation. Conversely, callable preferred stock gives the company the option to redeem the shares at a predetermined price, providing the company with more financial flexibility. However, this feature may be less desirable for investors, as it reduces the stability of their income stream. Companies must carefully consider the trade-offs between the benefits of these features and the impact on their cost of capital and financial flexibility when deciding to issue preferred stock.

Related terms

Common Stock:

Common stock represents an ownership interest in a corporation and grants the holder voting rights and a claim on the company\'s profits and assets.

Dividend: A dividend is a distribution of a portion of a company\'s earnings to its shareholders, typically paid periodically (e.g., quarterly or annually).

Liquidation Preference: The liquidation preference is the amount a preferred stockholder is entitled to receive per share in the event of a company\'s liquidation or dissolution, before common stockholders receive any payment.