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Finance for Non-Financial Managers
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terms of percent of face value or dollars per share.
Preferred shares are indeed a separate class of stock, with
privileges and restrictions different from common stock. And
they’re called preferred shares for good reason. When the
board of directors decides to declare a dividend to the share-
holders, the preferred shareholders must get their entire divi-
dend, based on the stated dividend rate, before any dividends
can be paid to the common shareholders. In some cases, the
preferred shares are also cumulative, meaning that dividends
not paid in one year accu-
Preferred stock Equity mulate as obligations of
ownership in a corporation the company and must be
that entitles the stockhold- paid up in full before any
ers to a specific dividend before any common stock dividends
dividends are paid on common stock. may be paid. For some
In the event of liquidation, preferred companies, that can mean
stockholders have rights to corporate
assets after bondholders and holders years of paying preferred
of other debt but before common dividends in full while giv-
stockholders. ing common stockholders
little or nothing.
In the event of the dissolution of a company with both pre-
ferred and common shares outstanding, the cash raised from
liquidating the assets is first used to repay all creditors. What’s
left goes to the stockholders, with the preferred stockholders
coming first. If there’s enough money to satisfy 100% of the pre-
ferred stockholders’ claims, then the balance goes to the com-
mon stockholders. If there’s not enough cash to satisfy both
groups of owners, there’s no pro-rata sharing between them.
The preferred shareholders get all of theirs and the common
shareholders get what is left, which may be nothing.
That, simply, is the meaning of the word “preferred.”
So why doesn’t every investor buy only preferred stock?
The downside of preferred stock ownership is the limitation on
participation in the extreme good fortune of the company. If a
company does very well, it can declare a very handsome divi-
dend for its common stockholders or give them additional