Characteristics of preference shares
Preference shares have a wide range of features. Corporate financial managers emphasize a set of features while issuing them. The main features or characteristics of preference shares are explained below:
1. Dividends for Preference share holders
Preference shareholders enjoy a priority over equity shareholders in payment of dividends. Only after paying dividend on preference shares, the company shall pay dividend to equity shareholders. Normally, the rate of dividend on preference shares is fixed by the controller of capital issues.
Preference shares may be
- cumulative preference shares or
- non-cumulative preference shares.
1. Cumulative Preference Share
With regard to cumulative preference shares, any dividend not paid by the company (in those years in which it made no profit) accumulates. The company must pay these unpaid dividends before the payment of dividends to equity shareholders. These unpaid dividends are called dividends-in-arrears.
2. Non-Cumulative Preference Share
Non-cumulative dividends are in contrast to cumulative dividends. Non-cumulative dividends do not accumulate if they are not paid when they become due.
2. Voting rights of preference shareholders
In India, preference shareholders have no right to vote in the annual general meeting of a company. As preference shareholders are relatively in a secure position, they have no right to vote except in the special circumstances. In the event of non-payment of dividend for two years or more, the preference shareholders can vote.
The voting right of each preference shareholder is to be in the proportion which the paid up share capital on his shares bears to the total equity share capital of the company.
3. Participating preference shares
Participating preference shares mean that the preference shareholder receives stipulated dividend and also participates in the additional earnings of the company along with the equity shareholders.
In practice, most preference shares are non-participating in nature. It means that the preference shareholder receives only his stated dividend and no more. The basis for this is that the preference shareholders surrender their claim to extra earnings in lieu of their right to receive the stated dividend.
4. Right on assets
Preference shareholders’ right on the assets of the company is similar to that of bond holders. When the company is liquidated, preference shareholders are paid and the residue is available to the equity shareholders. So, preference shareholders have a prior right to that of the equity shareholders.
However, preference shareholders claim their right only after the payment of bondholders.
5. Par value of preference shares
Usually, preference shares have a par value. It is the face value or denomination by which the preference share is valued. The dividend rate and call money are generally fixed with reference to the par value.
6. Redeemable preference shares
Preference shares have no maturity date. Redeemable preference shares are paid back (retired) to the preference shareholders by the issuing company. In other words, redeemable preference shares are retired by the company by paying the special sum as stated in the investment.
The terms of redemption are made known to the preference shareholders at the time of issue of shares. This arrangement is advantageous to the company. When money rate declines, the company may redeem the shares and refinance it at a lower dividend rate.
7. Sinking fund retirement
The retirement of preference shares calls for the payment of enormous funds. So, the company creates a special fund known as the sinking fund for the purpose of retirement.
Every year a stated sum is set apart in this fund and the accumulated sum is used to retire the preference shares when they become due. Thus, the payment out of sinking fund reduces preference shares outstanding. This will give the remaining preference shares a strong income position.
In other words, payment of dividend to the remaining preference shares is more certain. Ultimately, creation of sinking fund improves the investment status of preference shares.
8. Preemptive right of preference shareholders
Preemptive right means the preference shareholders have the right of receiving further issues from the company before it is offered to the public. This preemptive right is advantageous to the preference shareholders. They can receive the benefits of growth of the company by owning preference shares in addition to their original holding.
9. Convertibility of preference shares
Convertible preference share means that the owner has the right to exchange a preference share for equity share of the same company.
For example, a Rs.100 preference share may be convertible into 10 equity shares of Rs.10 each. At the time of issuing convertible preference shares, factors such as rights, privileges and the convertibility aspect, the rate of conversion and the number of shares offered at the time of conversion are made clear in a separate clause.
The convertibility clause entitles the preference shareholders to a share in the growth of the company.
10. Hybrid security of preference shares
The preference share is a hybrid stock between a bond and a common stock. A preference share partakes the characteristics of both the shares and the bonds. Like a bond, it has a claim on the assets of the company. At the time of liquidation of the company, only after the payment of principal to the preference shareholders, the claims of the equity shareholders can be satisfied.