6. Dividend
A distribution of a portion of a company's
earnings, decided by the board of directors,
to a class of its shareholders.
Can be issued as cash payments, as shares
of stock, or other property.
7. Basic Terms - Preferred Stocks
Preferred Stocks
− Preferred stock is a hybrid form of
financing, combining feature of debt and
common stock.
− Like bonds, preferred stock has a par
value and a dividend, that must be paid
before dividends can be paid on the
common stock.
− However, if the preferred dividend is not
earned, the directors can omit it without
throwing the company into bankruptcy.
8. Basic Terms - Preferred Stocks
Dividend
− The dividend paid on preferred stocks are
fixed, in terms of the rate at which it is paid.
− Holders of the preferred stocks must receive
a dividend (in the case of an ongoing firm)
before holders of common shares are entitled
to anything.
− Although preferred stock has a fixed payment
like bonds, which is at the discretion of the
board of directors and a failure to make this
payment will not lead to bankruptcy
9. Basic Terms - Preferred Stocks
Par Value
− Preferred shares have a stated par value.
− In case of liquidation the claim of preferred
stock holders is restricted to the par value of
the preferred stock.
− The claim of preferred stockholder’s on
assets comes after that of creditors but
before that of common stockholders.
10. Features of Preferred Stocks
Cumulative Dividend Feature
− A requirement that all cumulative unpaid
dividends on the preferred stock be paid before
a dividend may be paid on the common stock.
− For example, if the board of directors omits a
$6 preferred dividend for two years, it must pay
preferred shareholders $12 per share ($100 par
value) before any dividend can be paid to common
shareholders.
− The corporation does not have to make up the
dividend even if it is profitable, as long as the
firm has no plans to pay dividends to common
shareholders.
11. Features of Preferred Stocks
Participating Feature
− Preferred stock where the holder is allowed
to participate in increasing dividends if the
common stockholders receive increasing
dividends.
− Preferred stockholders have a prior claim on
income and an opportunity for additional
return if the dividends to common
stockholders exceed a certain amount.
12. Features of Preferred Stocks
Voting Rights
− Preferred stockholders are not normally given a
voice in management unless the company is unable
to pay preferred stock dividends during a specified
period.
− If such a situation presents itself, the class of
preferred stockholders would be entitled to elect a
specified number of directors.
− Any situation in which the company defaults under
restrictions in the agreement (similar to bond
indenture) may lead to voting power for preferred
shareholders.
− Preferred shareholders cannot force the
immediate repayment of obligations (like debt
obligations).
13. Features of Preferred Stocks
Retirement of Preferred Stocks
◦ Call Provision -- almost all issues carry a call
provision because of the infinite maturity. It is
often a cheaper method of retirement than
open market purchases, inviting tenders, or an
exchange of securities.
◦ Sinking Fund -- like bonds, many preferred
issues provide for this method of retirement.
◦ Conversion -- certain issues are convertible into
common stock at the option of the preferred
stockholder. Used most frequently in the
acquisition of other companies.
14. Use in Financing
• The corporate issuer uses irregularly because
the preferred dividend is not tax deductible.
• The corporate investor is attracted to
preferred stock as generally 70% of
dividends can be excluded from taxes.
• Flexibility in paying dividends and an infinite
maturity (similar to a perpetual loan) are
significant advantages to the corporate
issuer.
• The after-tax cost of preferred financing is
greater than that of long-term debt financing
to the corporate issuer.
