Why preferred shares are issued?
A number of reasons are commonly put forward for the issue of preferred shares rather than other forms of financing. In a survey of over 300 issuers of preferred shares over the period 1945 to 1965, one author, H.H. Elsaid, uncovered seven reasons. He asserted that preferred shares are issued to:
- Maintain a balanced capital structure;
- Improve the borrowing base for subsequent debt financing;
- Take advantage of market conditions;
- Provide financial leverage;
- Avoid fixed interest payment associated with debt;
- Preserve control for common shareholders;
- Facilitate merger or acquisition.
Features of preferred shares
Asset preference
The holder of preferred shares normally ranks after all creditors but before the common shareholders in the distribution of assets upon the winding-up of a firm. In winding up, the preferred shareholder is entitled to receive the stated or par value of each share plus any dividends owing. Since the creditors rarely receive all of their money in a bankruptcy, this asset preference is of dubious value.
Dividend preference
The preferred shareholder is usually entitled to a dividend before any dividend can be paid to the common shareholder in a given year. Preferred shares are normally given a par value and the dividend is stated as some percentage of par value.
Redemption
Callable preferred shares are similar to callable bonds in that they may be called at the option of the company.
Voting
The preferred shareholder is usually not allowed to vote preferred dividends have been omitted. That being the case, the typical allocation is one vote per share or the right to elect a certain number of directors.
