Definition of Preferential Dividends
Corporations finance themselves by either taking out loans or selling stock to investors. Most investors attribute equity ownership to common stock. Preference shares and dividends, however, also provide ownership privileges for investors.
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Identification
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Preferred shares feature asset claims that are junior to bonds, but superior to common stock. In the event of bankruptcy, bondholders are paid before preferred shareholders, who are then paid before common shareholders. In terms of dividends, preferred stock dividends must be paid before those on the common. Preferred dividends authorized to investors may accumulate when the corporation misses payments.
Features
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Preferred stocks are often described as perpetuities, where fixed dividend payments are made into the future with no maturity date. Preferred stock allows for growth in dividend payments by increasing them when the corporation exceeds certain profitability levels. Convertible preferred shares might be exchanged for a predetermined number of common equity shares.
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Considerations
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Preferred dividends are not tax-deductible expenses for businesses. All dividends are paid out of corporate net income to shareholders.
Misconceptions
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Contrary to common stock, preferred shares do not carry voting rights.
Risks
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Rising interest rates cause preferred share prices to fall. This happens because investors may receive higher interest payments on new bonds than the dividends upon old preferred stock.
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References
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