What is Preferred Stock?
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 ofthis financing are as follows:
Preferred Stock Advantages
a) Protects from dilution of control power:
It protects from dilution of control power because the 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.
b) Increases flexibility in capital structure and dividend payment:
It increases flexibility in capital structure and dividend payment. It may have call provision which increases the flexibility in the capital structure. Besides, dividends can be postponed if earning is insufficient.
c) Protects from dilution in earnings:
It protects from dilution in earnings. By issuing these 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:
It is less risky than long-term debt financing. If the firm is unable to pay periodic dividends or to redeem the stock at maturity, the stockholders can not take the company into bankruptcy. Because, from a legal point of view, the stockholders are owners of the company.
e) A permanent source of capital:
It is a permanent source of capital. Typically, preferred stock has no fixed maturity. However, if call provision is included, the company can call this stock ad to redeem them.
f) Ease in expansion:
It 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 these stocks than by issuing common stock.
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