Advantages of Preferred Stock Financing to the firm – Preferred Stock | Corporate Finance

Advantages of Preferred Stock
Preferred Stock | Corporate Finance
Management Notes

Preferred Stock which is also called preference share is a hybrid security with features of both debt and common stock which entitles the holder to pay a fixed dividend.Preferred shares generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights.From the firm’s viewpoint the major advantages of preferred stock financing are as follows:

a) Protects from dilution of control power:
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 voice in the management of the company. Hence, the control power of ordinary shareholders remains preserved.

b)Increases flexibility in capital structure and dividend payment:
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, dividend can be postponed if earning is insufficient.

c)Protects from dilution in earnings:
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.

d)Less risky than long-term debt financing:
Preferred stock financing is less risky than long-term debt financing. If the firm is unable to pay periodic dividend or to redeem preferred stock at maturity, preferred stockholders can not take the company into bankruptcy. Because, from legal point of view, preferred stockholders are owners of the company.

e)Permanent source of capital:
Preferred stock financing is permanent source of capital. Typically, preferred stock have no fixed maturity. However, if call provision is included, company can call preferred stock ad redeem them.

f) Ease in expansion:
Preferred Stock Financing facilitates those firms that want to expand their business because preferred stock secures the interest of the shareholders as they have a prior claim on the earning and assets. Hence, the company can raise a greater fund by issuing preferred stocks than by issuing common stock.

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