What are preference shares?
Preferred shares (also called preference shares or preferred stock) are a type of security that gives the owner a stake in a corporation and a preferential right to the company's earnings and assets. Preferred shares rank higher than common shares but lower than bonds regarding their claim on the company's assets. Unlike common shareholders, preferred shareholders usually receive fixed dividends regularly. I.e., Preference shares give their owners some special rights over the regular equity shareholders. For example, preference shareholders get paid first when a company distributes dividends or goes bankrupt. This makes preference shares more secure and attractive than common equity shares.
Preference Shares Explained
Preference shares fall under four categories: cumulative preferred stock, non-cumulative preferred stock, participating preferred stock, and convertible preferred stock.
A company must pay all the dividends to cumulative preferred stockholders, even if they missed some payments in the past, before they can pay any dividends to common stockholders. These dividends are promised but not always paid on time. When dividends are not paid when due, they are called "dividends in arrears," and they belong to whoever owns the stock when the payment is made. Sometimes, this type of preferred stockholder also gets extra compensation (interest) for the delayed payment.
Non-cumulative preferred stockholders do not get any missed or unpaid dividends. If the company decides not to pay dividends in a certain year, the stockholders of the non-cumulative preferred stock have no right or power to demand those dividends later.
Shareholders with participating preferred stock receive dividends at a fixed rate plus an extra amount based on a certain condition. Usually, this extra amount is only paid if the common shareholders get more dividends than a fixed amount per share. If the company goes bankrupt, participating preferred shareholders may also get back the money they paid for the stock and a share of the remaining money that goes to common shareholders.
Shareholders with convertible preferred stock can change their preferred shares into a fixed number of common shares, usually after a certain date. Normally, this change happens at the shareholder's request. However, some shares may have a provision that allows the shareholders or the company to force the change. The value of convertible common stocks depends on how well the common stock does