Preferred stock
Hybrid security ranking between common stock and bonds.
Preferred stock—also known as preferred shares, preference shares, or simply preferreds—is a type of share capital that blends features of both equity and debt, making it a hybrid instrument. It sits above common stock but below bonds in the hierarchy of claims on a company’s assets. This means preferred shareholders get priority over common shareholders when dividends are paid and if the company is liquidated. The specific terms of preferred stock are laid out in the company’s articles of association or incorporation.
Like bonds, preferred stocks receive ratings from major credit agencies, though these ratings are typically lower than those for bonds. That’s because preferred dividends lack the same guarantees as bond interest payments, and preferred holders’ claims rank behind all creditors. The term “preferred equity” is similar but usually applied to real estate or other private investments where common stock isn’t publicly traded, so it carries no public credit rating.
**Features** Almost all preferred stocks share several common traits: - Preference in dividend payments - Preference in asset distribution during liquidation - Callability (the company can redeem them early, sometimes subject to a spens clause) - Higher dividend yields compared to common stock - Convertibility into common stock - Typically no voting rights
**Preference in dividends** Preferred stock generally has priority in dividend payments. This doesn’t guarantee a dividend will be paid, but the company must pay the stated preferred dividends before or at the same time as any common stock dividends. Preferred stock can be cumulative or noncumulative. With cumulative preferred, if a company misses a dividend (or pays less than the stated rate), it must make up the missed amount later before paying common dividends again. Missed dividends accumulate over each passed period (quarterly, semi-annually, or annually) and are called dividends in arrears. Noncumulative, or straight, preferred stock does not have this feature—any missed dividends are lost if not declared.
**Other features or rights** Preferred stock may or may not have a fixed liquidation value (or par value), which represents the capital originally contributed when shares were issued. In liquidation, preferred stock has a claim equal to its par or liquidation value, senior to common stock’s residual clai
- Type
- Hybrid equity/debt instrument
- Seniority
- Senior to common stock, subordinate to bonds
- Dividend Preference
- Priority over common stock dividends
- Liquidation Preference
- Priority over common stock, up to par value
- Voting Rights
- Typically nonvoting; may gain voting rights if dividends in arrears
- Credit Rating
- Rated by major agencies, generally lower than bonds
- Common Features
- Callability, convertibility, fixed or floating dividends
Lore & Background
Preferred stock combines features of equity and debt, offering fixed dividends and priority over common stock in dividends and liquidation. It is issued under terms set in a company's articles of incorporation. Most preferred shares are callable, convertible, and nonvoting, though cumulative preferred shares may gain voting rights if dividends are in arrears. Dividends may be cumulative or noncumulative; passed dividends on cumulative stock accumulate as arrears.
Reader's Guide
Preferred stock serves as an alternative financing tool, allowing companies to defer dividends without immediate default, unlike traditional debt. It is used in corporate finance, including as a defense against hostile takeovers through blank-check provisions or poison pills. The market includes diverse types such as prior preferred, convertible preferred, and monthly income preferred stock (MIPS), which at one point dominated new preferred issues. Credit rating agencies treat MIPS as preferred stock. Preferred stock's hybrid nature makes it significant for investors seeking higher yields than bonds but with greater risk, as its claims are junior to all creditors.
Did You Know?
- Preferred stock is generally considered a hybrid instrument, combining features of equity and debt.
- Cumulative preferred stock requires that missed dividends be paid later before common dividends can resume.
- Monthly income preferred stock (MIPS) was introduced by Goldman Sachs in 1993 and at one point accounted for over 70% of new preferred issues.
- Preferred shares may have special voting rights to approve extraordinary events, such as the issuance of new shares or acquisition of a company.
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