Preferred Stock

Stock that takes priority over common stock with regard to dividends and liquidation rights. Preferred stockholders typically have no voting rights.

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, but are subordinate to bonds. Preferred stock usually carries no voting rights, but may carry a dividend and may have priority over common stock in the payment of dividends and upon liquidation. 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. 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 stockIn 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. 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.

A stock that doesn't have this feature is known as a noncumulative or straight preferred stock and any dividends passed are lost forever if not declared.

Preferred shares, like other legal arrangements, may specify nearly any right conceivable. Preferred shares in the U. S. normally carry a call provision, enabling the issuing corporation to repurchase the share at its (usually limited) discretion. In addition to the straight preferred, as just described, there is great diversity in the preferred stock market. Additional types of preferred stock include: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.

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, creating preferred shares with a poison pill 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). These shares may be assigned very high liquidation value that must be redeemed 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 or junior relationship with other series issued by the same corporation.

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 are encouraged to issue preferred stock as a source of Tier 1 capital. On the other hand, the Tel Aviv Stock Exchange prohibits listed companies from having more than one class of capital stock. 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.