Preferred Stock is a class of ownership inside a corporation with a higher claim around the assets and cash flow than common stock. It is a share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends. One advantage of preferred stocks is their tendency to pay higher and more regular dividends than the same company’s common stock. It generally features a dividend that must definitely be paid out before dividends to common stockholders and also the shares tend not to have voting protection under the law.
From the firm’s viewpoint the major advantages of preferred stock financing are as follows:
(1) Preferred stock financing protects from dilution of control power. Because the preferred stockholders do not have voting right unless the dividend arrears exist. Thus, they do not have a voice in the management of the company. Hence, the control power of ordinary shareholders remains preserved.
(2) A preferred stock is more flexible in comparison to debt when a company is financially distressed or when it comes to missing an annual payment.
(3) Preferred stock financing increases flexibility in capital structure and dividend payment. Preferred stocks may have call provision which increases the flexibility in capital structure. Besides, a dividend can be postponed if earning is insufficient.
(4) Preferred stock financing helps to conserve mortgageable assets.
(5) Preferred stock financing protects from dilution in earnings. By issuing preferred stocks, the company can avoid the provision of equal participation in earnings that the sale of additional common stock would require and protects from dilution in earnings.
(6)It is useful for corporate restructuring or reorganization (Corporate restructuring is the process of reconstructing a whole organization or certain divisions of a corporation).
(7) Preferred stock financing is less risky than long-term debt financing. If the firm is unable to pay a periodic dividend or to redeem preferred stock at maturity, preferred stockholders can not take the company into bankruptcy. Because, from a legal point of view, preferred stockholders are owners of the company.
(8) Preferred stock financing is a permanent source of capital. Typically, preferred stock has no fixed maturity. However, if the call provision is included, the company can call the preferred stock to redeem them.
From investor’s point of view preferred stock financing have following advantages:
(1) Preferred stocks provide reasonably regular and stable income as preferred stock dividends are fixed.
(2) Preferred stockholders have a preference over common stockholders in income and assets.
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