When it comes to issuing preferred stock, owners tend to have preferential treatment compared to those who own common stock. Preferred stockholders get their dividends earlier than common stockholders do. This means if a corporation doesn't declare and pay the required dividends to the preferred stock, a dividend cannot go on the common stock. In exchange for these prefers, the stockholders often give up their right to participate in the corporation's earnings that come from an excess of the dividends. Preferred stock doesn't often convey voting rights to the owners like common shares do.

Preferred Stock

Investors who are looking for dividends find preferred stock attractive, as it gives owners a set rate of return instead of returns that increase and decrease with the stock market. This means it acts more like a bond with a fixed payout. For an example of how preferred stock works, assume a company has given out preferred stock with an annual dividend of $10 per year. The preferred shareholders need to receive the $10 per share dividend every year before the common stockholders get a penny in the dividends.

However, the preferred shareholders won't get any more than the $10 dividend, even if the net income goes up drastically. When inflation happens, it's not as attractive to have preferred stock that has a fixed dividend and no redemption or maturity date.

Par Value of Preferred Stock

A preferred stock dividend is often stated as a percentage of the par value. That means the par value holds slight economic significance. If a corporation gives out 9 percent preferred stock that has a par value of $100, the stockholder will get a dividend of $9 per share every year, which is 9 percent multiplied by $100. If the company gives out 10 percent preferred stock with a par value of $25, the dividend will be $2.50 each year.

In these examples, the par value is important since it plays a role in determining the dividend amounts. If the percentage of the preferred stock is similar to the rate that the financial markets demand, the preferred stock will sell for a price that's close to the par value.

In keeping with state regulations, the par value for preferred stock gets recorded in a separate capital account. If the corporation gets more than the par amount, the difference that's greater than par gets recorded in a different account.

Preferred Stock Features

Corporations have varying features they can offer in their preferred stock, and the goal is to make their stock look attractive to possible investors. The following are characteristics of preferred stock issue:

  • Participating versus non-participating.
  • Noncumulative versus cumulative
  • Callable
  • Convertible
  • Combination of different features
  • Not debt
  • Referred dividends
  • Provides flexibility

Preferred stockholders often get their stated dividends and nothing else. If the stock is 10 percent preferred stock that has a par value of $100, the dividend will be $10 per year. Preferred stock that doesn't earn any more than the stated dividend is normal and is known as non-participating preferred stock. Sometimes a company gives out participating preferred stock, which allows dividends that are more than the dividend that's stated. This is an unusual feature and not often seen.

If the stock is cumulative, the holders need to receive past dividends that got omitted on the current year dividend and preferred stock. This must happen before the stockholders receive dividends. If a company is suffering operating losses and doesn't have much cash available, they might omit the dividends. If a corporation leaves out a dividend on the cumulative preferred stock, the omitted dividends are in arrears and noted as closed in the notes section of the financial statements. If the stock is non-cumulative, the dividends are not in arrears if they are left out.

If a company has 10 percent outstanding preferred stock and the market rates bring it down to 8 percent, the corporation is likely to eliminate the original 10 percent stock and put the 8 percent preferred stock in its place. However, holders of the original 10 percent stock will assume they're getting 10% for the rest of the time they own the stock

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