Key Takeaways

  • Callable preferred stock allows issuers to repurchase shares at a set price after a certain date.
  • It combines features of debt (fixed dividends) and equity (ownership stake).
  • Key terms include par value, dividend rate, call price, call premium, and call date.
  • Issuers benefit from flexibility to refinance when interest rates fall.
  • Investors face reinvestment risk, since shares may be redeemed early if rates drop.
  • Callable preferred stock often carries higher dividends to compensate investors for risk.
  • While issuers gain cost control and capital flexibility, investors may see limited price appreciation.
  • Businesses must weigh alternatives such as non-callable preferred stock or rights of first refusal.

How Callable Preferred Stock Works

Callable preferred stock is simply preferred stock that can be repurchased or redeemed by the issuer business - in this case, your business.  The issuer has the option to repurchase the stock according to terms set out in the prospectus, a special type of contract that covers an investment offering.

Callable preferred stock is the “best of both worlds,” so to speak - with callable preferred stock, you can enjoy the benefits of both equity and debt financing while avoiding the drawbacks. When you issue callable preferred stock, you can raise funds without having to make loan payments or give up a permanent stake in your company.

There are four key terms related to the issuance of preferred stock:

1. The share price is the amount each share is worth at the time of sale.  It is sometimes referred to as the “par stock value.”

Example: If you sell ten preferred shares at a $10 share price, you will receive $100.

2. The dividend rate is a fixed amount payable as set out in the prospectus.  The dividend rate is based off of the par value of the preferred stock.

Example: If there is a 5% dividend rate on $100 par value of callable preferred stock sold to a given shareholder, you will need to pay that shareholder $5 per year in dividends for the length of such ownership.

3. The call price is the pre-determined price you pay to repurchase the preferred shares. It is frequently priced higher than the original share price, and may include unpaid dividends.  When the call price is higher than the share price, the difference is known as the “call premium.” Depending on the terms of the prospectus, the call premium may decrease over time.

Example: If the call price is $11 for 10 shares, you can decide to repurchase the shares for $110 at any time on or after the call date. The shareholder cannot refuse to sell, nor can they ask for a higher price. Full ownership rights go back to you, and you no longer need to pay dividends.

If the stock would trade on the market at above the call price, then the likelihood of you benefiting from repurchasing the shares -- and therefore actually repurchasing the shares -- increases.  As such, the price appreciation of the stock is effectively capped at the call price.  This means that investor demand can be significantly cooled for callable stock when the trading price is close to or above the call price.

4. The call date is the date when you are first allowed to call preferred shares.  There is no minimum or maximum call date, though many issuers set call dates at 3-5 years after the stock has been issued.

The issuer is not required to “call” the shares after the call date.  The issuer may or may not, at their discretion.

Callable preferred stock can be saddled with any number of other requirements before repurchase or redemption is allowed.  The call date is simple a common requirement.

When the stock is called, the difference between the market value and par value of the stock is not treated as either a gain or a loss.  It is either debited to retained earnings (if there has been a loss) or credited to additional paid-in capital on the preferred stock (if there has been a gain).

Key Features of Callable Preferred Stock

In addition to the basic mechanics, several distinct features define callable preferred stock:

  • Reinvestment Risk: Investors may receive their principal back earlier than expected if the stock is called, forcing them to reinvest at lower prevailing rates.
  • Dividend Yield Premium: To attract buyers, callable preferred stock often offers a higher dividend yield compared to non-callable issues, compensating investors for the call risk.
  • Market Price Limitations: Because investors know the stock can be redeemed, its market price rarely rises far above the call price, capping upside potential.
  • Creditworthiness Factor: Issuers with stronger credit ratings are more likely to successfully issue callable preferred stock, since investors trust the dividend stream despite the call feature.

Why Callable Preferred Stock Is Important

Callable preferred stock gives you control over your financing costs.

If rates fall, you can repurchase the stock at the call price and issue new shares paying a lower dividend rate.

Suppose that you issued shares at a 10% dividend rate.  Interest rates decline, however, and you can repurchase the shares and reissue them at a lower 5% dividend rate.  This gives you a great deal of flexibility to adapt to the changing market.

If rates rise, you can leave the shares outstanding and continue to pay a fixed dividend rate lower than prevailing market interest rates.

However, because callable preferred stock empowers the issuer and shifts a great deal of risk to the investor, callable stock is typically issued with a high dividend rate to account for such risk.

Callable vs. Non-Callable Preferred Stock

Callable preferred stock differs from non-callable preferred stock, which cannot be redeemed early by the issuer. This distinction has several implications:

  • Issuer Advantage: Callable stock lets businesses restructure financing when market conditions shift.
  • Investor Advantage (Non-Callable): Non-callable stock protects investors from reinvestment risk, since their dividend stream is secure for the life of the stock.
  • Dividend Rates: Callable issues tend to carry higher dividend rates than non-callable ones, balancing the issuer’s flexibility with investor risk tolerance.
  • Liquidity & Market Value: Non-callable preferred stock may trade at higher prices in the secondary market, since buyers know it cannot be taken away before maturity.

Reasons to Consider Using Callable Preferred Stock

Preferred stock confers several advantages compared to standard debt and equity financing. Preferred stock allows you to...

  • Avoid permanently giving up a majority interest in your company.
    • Shares can be repurchased after the call date.
  • Maintain voting control.
    • Preferred shares can be classified as non-voting shares.
  • Leave common shares available for equity incentive plans.
  • Control your funding costs.
  • Repurchase shares at a fixed price when you have surplus cash.
    • The call price for repurchasing shares is set at the time the prospectus contract is executed.

Situations Where Callable Preferred Stock Is Most Useful

Issuing callable preferred stock can be especially beneficial in these scenarios:

  1. Falling Interest Rate Environments – Issuers can call outstanding shares and reissue new preferred stock at lower dividend rates.
  2. Debt Reduction Goals – Companies with excess cash may retire preferred stock early to lower fixed dividend obligations.
  3. Capital Structure Flexibility – Issuers can balance between equity and debt, retaining the ability to reclaim ownership.
  4. Strategic Growth Funding – Startups or growing firms may use callable preferred stock as a way to attract investors without permanently giving up control.

Reasons to Consider Not Using Callable Preferred Stock

Preferred stock may not be ideal for all financing situations, however.

  • Investors may not be willing to pay as much for equity subject to call.
    • The perceived value of callable preferred stock is likely to be lower as such shares have less upswing potential.  Investors who are looking to cash in significant gains on their price-appreciated callable preferred stock must do so before the issuer announces a call, as a call announcement can send share values plummeting towards par value.
    • On the other hand, “call price premiums” guarantee a return even if the markets underperform.  Some investors therefore find such an arrangement advantageous.
  • Preferred stock receives preference over common stock in the event of a liquidation or restructuring.
  • You may not pay dividends to common shareholders unless preferred shareholder dividends are paid in full.
    • This can be a problem if you have overextended yourself with high dividend rates for preferred stock shareholders.
  • Adding securities classes complicates your corporate structure and may impose additional compliance costs.
  • There are alternatives for retaining tightened ownership and control of the business.
    • You can issue stock with a right of first refusal, which allows you to match third-party offers to buy company stock from a shareholder.

Risks and Drawbacks for Investors

From an investor’s perspective, callable preferred stock presents several downsides:

  • Reinvestment Risk: If the stock is called, investors may have to reinvest returned capital at lower interest rates.
  • Limited Price Upside: Since shares are capped at the call price, investors have reduced capital gains potential.
  • Issuer-Favorable Terms: Calls almost always benefit the issuer, not the investor—stocks are typically called when dividend rates are higher than market rates.
  • Income Uncertainty: While dividends are typically fixed, the potential early redemption creates uncertainty in long-term income planning.

Is Callable Preferred Stock Right for Your Business?

Callable preferred stock is worth considering if you're currently exploring financing options for your startup, but would like to avoid the pitfalls of standard debt and equity financing.  Repurchasing callable preferred stock is easy.  Notice must be sent to the relevant shareholders with details on the various repurchase conditions.

Each alternative has its own balance of control, investor appeal, and cost. Companies should weigh these carefully when deciding how to raise capital.

Alternatives to Callable Preferred Stock

If callable preferred stock does not align with your goals, consider alternatives such as:

  • Non-Callable Preferred Stock: Provides stability to investors and may attract long-term capital.
  • Convertible Preferred Stock: Allows investors to convert preferred shares into common equity, offering growth potential.
  • Cumulative Preferred Stock: Ensures unpaid dividends accumulate and must be repaid before common shareholders receive dividends.
  • Debt Financing: Bonds or loans may provide more predictable repayment terms without ownership dilution.

Frequently Asked Questions

1. What is callable preferred stock?

Callable preferred stock is a type of preferred share that can be redeemed by the issuing company at a predetermined price after a specified date.

2. Why would a company issue callable preferred stock?

Companies use it to maintain flexibility—repurchasing shares when interest rates drop, refinancing at lower dividend rates, or managing capital more efficiently.

3. How does callable preferred stock affect investors?

Investors face reinvestment risk, since issuers often call shares when it is least advantageous for investors, though higher dividends are offered as compensation.

4. What is the difference between callable and non-callable preferred stock?

Callable stock can be redeemed by the issuer early, while non-callable stock cannot, making the latter more secure but often with lower dividends.

5. Is callable preferred stock a good investment?

It depends on the investor’s goals. It may be attractive for those seeking higher dividends, but less appealing for investors who prioritize long-term income stability and capital appreciation.

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