Preference shares are identically issued by companies. The aim is to raise capital from the companies. It also combines the characteristics of debt and equity investments. In other words, it is consequently to be hybrid securities.
Preference shareholders receive dividend payments before common shareholders. They don’t enjoy voting rights like their common shareholder counterparts do. In addition, companies incur higher issuing costs with preferred shares than they do when issuing debt.
Here are the pros and cons of preference shares.
Higher Claim one Company Assets
Preferred shareholders have a higher claim on company assets that common shareholders do. It happens in the event that a company experiences a bankruptcy and subsequent liquidation.
Not surprisingly, preference shares attract conservative investors, who enjoy the comfort of the downside risk protection baked into these investments.
Additional Investor Benefits
Convertible shares or a subcategory of preference shares lets investors trade in these types of preference shares for a fixed number of common shares. Therefore, it can be lucrative if the value of common shares begins climbing.
Such participating shares let investors reap additional dividends that are above the fixed rate if the company meets certain predetermined profit targets.
The Disadvantages of Preference Shares
The main disadvantage of owning preference shares is that the investors in these vehicles don’t enjoy the same voting rights as common shareholders. This means that the company is not beholden to preferred shareholders the way it is to traditional equity shareholders.
Although the guaranteed return on investment makes up for this shortcoming, if interest rates rise, the fixed dividend that once seemed so lucrative can dwindle.
This could cause buyer’s remorse with preference shareholder investors, who may realize that they would have fared better with higher interest fixed-income securities.
In addition, you need to highlight about financial through shareholder. The sign of a well-managed business is about financing through shareholder equity. It is addressed either common or preferred shares or lowers a company’s or debt-to-equity ratio.
Company Benefits
Preference shares benefit issuing companies in several ways. The aforementioned lack of voter rights for preference shareholders places the company in a strength position, by letting it retain more control.
Furthermore, companies can issue callable preference shares, which affords them the right to repurchase shares at their discretion. This means that if callable shares are issued with a 6% dividend but interest rates fall to 4%, then a company can purchase any outstanding shares at the market price, then reissue those shares with a lower dividend rate.
This ultimately reduces the cost of capital. Of course, this same flexibility is a disadvantage to shareholders.
