Preferred Stock is one of the two main types of stock. Generally, it has a higher priority with respect to the asset distribution in the company compared to the other ones – that’s why it is preferred.
There are two main scenarios where it exposes its advantages the most.
The first one is when the company needs to share the profit it earned during a certain period among the owners. In other words, distribute the dividends among the shareholders. In this case, the preferred stockholders will have higher priority and may have a higher yield and choose various payment options.
The second one is when the company files for bankruptcy. In this case, the company owners will want to take back the money they invested in the company – proportionate to their share in the total capital. However, as the company filing for bankruptcy, naturally, has much fewer assets than it used to, the total amount to be divided among the owners will be less than what it used to be, especially after the bondholders have their claims satisfied as to the highest priority. In other words, some of the shareholders may not receive their money back. Some, but not the preferred stockholders – this security gives a certain degree of reassurance through giving a higher priority on its owner’s claim.
Hence, the nature of preferred stock is a fusion of a bond and equity due to the higher level of guarantee on the outcomes in certain scenarios.
However, there is one disadvantage that balances that out – preferred stock usually do not have voting right.
2020-07-24 • Updated