Rules and Rights of Common and Preferred Stock

This article explains the rights of shareholders, depending on what kind of stock they own, including the right to claim income in the case of bankruptcy, voting rights, and the right to buy newly created shares. This section further differentiates preferred stock and common stock.

Provisions of Preferred Stock

Preferred shares have numerous rights which can be attached to them, such as cumulative dividends, convertibility, and participation.


LEARNING OBJECTIVE

  • Describe in detail the different types of provisions for preferred stock

KEY POINTS

    • If a preferred share has cumulative dividends, then it contains the provision that should a company fail to pay out dividends at any time at the stated rate, then the issuer will have to make up for it as time goes on.
    • Convertible preferred stock can be exchanged for a predetermined number of company common stock shares.
    • Often times companies will keep the right to call or buy back preferred shares at a predetermined price.
    • Participating preferred issues offer holders the opportunity to receive extra dividends if the company achieves predetermined financial goals.
    • Sometimes, dividends on preferred shares may be negotiated as floating; they may change according to a benchmark interest-rate index.

TERMS

  • Convertible preferred stock

    Convertible preferred stock can be exchanged for a predetermined number of company common stock shares.

  • Cumulative Dividends

    Condition where owners of certain shares will receive accumulated dividends in the case a company cannot pay out dividends at the stated rate at the stated time.

  • Callable shares

    Shares which can be bought back by the issuer at a predetermined price.


Preferred stock may be entitled to numerous rights, depending on what is designated by the issuer. One of these rights may be the right to cumulative dividends. Preferred stock shareholders already have rights to dividends before common stock shareholders, but cumulative preferred shares contain the provision that should a company fail to pay out dividends at any time at the stated rate, then the issuer will have to make up for it as time goes on.


Historical dividend information for Franklin Automobile Company:  Dividends are one of the privileges of stock ownership, and preferred shares get more rights to them than common shares do.

Convertible preferred stock can be exchanged for a predetermined number of company common stock shares. Generally, this can occur at the discretion of the investor, and he or she may pick any time to do so and, therefore, take advantage of fluctuations in the price of common stock. Once converted, the common stock cannot be converted back to preferred status.

Often times companies will keep the right to call or buy back preferred shares at a predetermined price. These shares are callable shares.

There is a class of preferred shares known as "participating preferred stock". These preferred issues offer holders the opportunity to receive extra dividends if the company achieves predetermined financial goals. Investors who purchased these stocks receive their regular dividend regardless of company performance (assuming the company does well enough to make its annual dividend payments). If the company achieves predetermined sales, earnings, or profitability goals, the investors receive an additional dividend.

Almost all preferred shares have a negotiated, fixed-dividend amount. The dividend is usually specified as a percentage of the par value, or as a fixed amount. Sometimes, dividends on preferred shares may be negotiated as floating; they may change according to a benchmark interest-rate index or floating rate. An example of this would be tying the dividend rate to LIBOR.