Preferred Shares

Preferred shares are a hybrid form of capital that have some of the qualities of bonds and some qualities of common stock. Like bonds, preferred shares pay a fixed return to their holders at regular intervals. These dividends may be stated as a percentage of the par value of the preferred shares, or as a fixed amount. Unlike bonds, holders of preferred shares may receive additional dividends from company earnings, provided the preferred shares are participating. Why, then, would an investor prefer bonds to preferred shares? Bondholders have priority over holders of preferred shares in both receiving fixed payments and getting back their invested capital in case of bankruptcy. Unlike interest on bonds, which must be paid to avoid default, a company’s board of directors can legally skip a dividend payment on preferred shares. If the preferred shares are cumulative (as most are), the company must make all dividend payments in arrears before common stockholders can receive profits. Finally, note that dividends on preferred shares are not tax-deductible to the company, making them an expensive form of capital.

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