Features & Advantages of Preferred Stock

 Features of Preferred Stock

A number of features are generally included as part of a preferred stock issue. These features, along with the stock’s par value, the amount of dividend payments, the dividend payment dates, and any restrictive covenants, are specified in an agreement similar to a bond indenture.

Restrictive Covenants:

The restrictive covenants in a preferred stock issue are aimed at ensuring the firm’s continued existence and regular payment of the dividend. These covenants include provisions about passing dividends, the sale of senior securities, mergers, sales of assets, minimum liquidity requirements, and repurchases of common stock. 

The violation of preferred stock covenants usually permits preferred stockholders either to obtain representation on the firm’s board of directors or to force the retirement of their stock at or above its par or stated value. 

Cumulation: 

Most preferred stock is cumulative with respect to any dividends passed. That is, all dividends in arrears, along with the current dividend must be paid before dividends can be paid to common stockholders. 

If preferred stock is noncumulative, passed (unpaid) dividends do not accumulate. In this case, only the current dividend must be paid before dividends can be paid to common stockholders. Because the common stockholders can receive dividends only after the dividend claims of preferred stockholders have been satisfied, it is in the firm’s best interest to pay preferred dividends when they are due.

Other Features:

Preferred stock is generally callable—the issuer can retire outstanding stock within a certain period of time at a specified price. The call option generally cannot be exercised until a specified date. The call price is normally set above the initial issuance price, but it may decrease as time passes.

Making preferred stock callable provides the issuer with a way to bring the fixed-payment commitment of the preferred issue to an end if conditions in the financial markets make it desirable to do so. 

Preferred stock quite often contains a conversion feature that allows holders of convertible preferred stock to change each share into a stated number of shares of common stock. Sometimes the number of shares of common stock that the preferred stock can be exchanged for changes according to a prespecified formula.

Advantages of Preferred Stocks for the Shareholders:

• Dividends: 

The dividend of the company is paid before paying the common stock holders. It ensures that the investment is less risky than investing in common stocks.

• Higher Claim: 

The preferred stocks have a higher claim on the company’s asset. If the company goes for a bankruptcy, the preferred stock holders are paid first from the remaining assets.

• Opportunities of Other Investments: 

Some preferred stocks have the convertible features. It gives an investors to convert to common stocks which is an opportunity of price gain.