How Is Preferred Stock Like Long-Term Debt?
Preferred stocks are equity securities that represent partial ownership in a company, but they have more in common with long-term debt securities (bonds) because of features that make them act more like bonds.
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No Voting Rights
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Stockholders have the right to vote on the important affairs of the corporation and elect the board of directors at an annual meeting. Although they represent ownership, preferred stocks, like bonds, carry no voting rights.
Perpetual Securities
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Most preferred stocks are perpetual securities: they have no maturity dates. Long-term bonds are issued with a 20- or a 30-year maturity. For all intents and purposes, this is a lifetime for most investors. Both preferred stocks and long-term bonds can have call provisions -- the ability of the issuer to call, or redeem, them at some future date under certain conditions.
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Limited Upside Potential
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Both bonds and preferred stocks have a limited upside potential. Bonds have a limited upside potential because they will eventually be paid off at face value at maturity or called earlier. Preferred stocks have limited upside potential because they can be called at par, or stated, value.
High Yield
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Preferred stocks usually pay high dividends to compensate investors for lack of voting rights and limited upside potential. Long-term bonds pay higher interest than other types of fixed income securities. In fact preferred stock dividend yields are often very similar to those of long-term bonds of comparable credit quality.
Interest Rates Sensitive
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Fixed income securities are sensitive to interest rates. When interest rates go up, fixed income securities go down, and vice versa. Both preferred stocks and long-term bonds fluctuate in similar fashion in response to interest rate changes.
Claims Against Corporate Assets
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Both preferred stockholders and bondholders have the right to lay a claim against corporate assets in a bankruptcy or dissolution, although bondholders' claims are paid ahead of those of preferred stockholders.
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