Advantages & Disadvantages of Issuing Preferred Stock
Preferred stockholders represent secondary ownership in a company. These stockholders do not have the right to vote and govern the matters of the company and hence are called secondary stockholders. Every quarter that the company declares dividends, it first pays preferred stock holders and makes payments to common stockholders. Even when the company is liquidated, if any money remains, the preferred stockholders are paid before common stockholders.
From the company perspective, there are both pluses and minuses of issuing preferred stocks.
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Fixed Rate of Dividends
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The main benefit to the company is that the rate of dividend is fixed throughout the lifetime of the stock. A 5 percent preferred stockholder is always paid dividends at the rate of five percent, regardless of the magnitude and volume of profits made by the company. This is not the case with common stocks. Once the company has met its remaining financial obligations, common stockholders share the profits that remain. Because the rate of dividends are fixed, the company knows well in advance the expenditures in paying the dividends and is therefore able to plan and budget.
Voting Rights
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Preferred stockholders are not given the right to vote in the conduct of the affairs of the company. Only common stockholders have the right. The benefit that the company derives from issuing preferred shares is that it does not dilute its ownership structure.
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Non-Risky forms of Investment
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Usually, the prices of preferred stocks do not fluctuate much. As the investor is confident that he would be able to recover at least the amount that he invested in the company, he is lured into buying preferred stocks. In addition to recovering his initial investment, he also gets dividends as and when the company declares them.
As the prices remain stable, the image of the company also remains good in the market. When there is a steep downward movement in the prices of the shares, the reputation of the company falls.
Taxation
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The main disadvantage of issuing preferred stocks is that the company is liable to pay taxes on the amount of dividends paid to the stockholders. When a company raises debts, it is required to pay its creditors interest on the debt. The interest paid is exempt from taxation.
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