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Also known as preferred shares or preferred stock, preference shares are stock options that provide payments to preferred investors before any dividends are paid to holders of common stock issued by the same corporation. In most instances, the amount of this dividend is fixed, as opposed to the variable dividend that is available to investors with common stock. There are several benefits associated with holding these types of shares, although investors with preferred shares do not usually enjoy the same voting privileges as investors with common shares.
Two of the more prominent benefits associated with owning preference shares are the fixed dividend payments and the senior status in the event that the issuing entity should declare bankruptcy. With the fixed amount of the dividend, investors can depend on receiving a specific amount of return on their shares, as long as the company is generating enough profit to comply with the terms within the stock agreement that have to do with the issuing of dividends. Assuming that the company remains financially stable and is able to maintain its market share, this means the payments are regular and easy to predict.
Holders of preference shares also have precedence in the event that the corporation must undergo liquidation. Investors with preferred stock will receive some type of compensation for their shares before any investors with common shares. Depending on the laws that are in force in the area where the business is located, the court of jurisdiction will often determine just how much compensation is received for each of the preference shares. This greater claim on the assets of the company enhances the opportunity to avoid incurring a loss if and when the business fails and its assets must be liquidated in order to settle outstanding debts to lenders and other types of creditors.
While there are benefits to owning preference shares, there are also some drawbacks. Typically, investors holding preferred stock do not participate in votes taken at general meetings. This is in contrast to investors with common shares, who normally do vote at those meetings. In addition, the terms of the fixed dividend payment often require that the business earn a certain level of profit before dividends are issued to shareholders of any type, especially preferred shareholders. This means that a company operating at a deficit may not issue payments to preference investors for an extended amount of time. While investors with preference shares will receive dividends before any payments are tendered to investors with common shares, holding preferred stock does not automatically guarantee that dividends will be issued in all instances.
It is not unusual for companies to issue preference shares that are considered to be convertible. This means that under certain circumstances, the shares may be converted from preferred to common stock option. Depending on the terms related to the issuance of the shares, investors may have the option to request the conversion under certain circumstances. The terms will also allow the issuer to make the conversion should certain events in the marketplace occur that make the change in the best interests of all concerned.