The primary advantage to an investor of holding preferred stock compared with common stock is that the preferred stock return is somewhat more predictable (more certain). The issuing company will generally make a real effort to try to avoid defaulting on the preferred stock dividend. Since the return to preferred stock is reasonably well defined and since the preferred stockholders precede the common stockholders (the preferred dividends are paid before the common dividends), preferred stock is a popular type of security for executing mergers and acquisitions.
From the point of view of an issuing corporation’s common stockholders, preferred stock offers the opportunity to introduce a form of leverage that could benefit the common stockholders if the corporation does very well in the future. The preferred stockholders do not normally participate in any bonanza that might occur since their dividend rate is either fixed or, if variable generally has a set maximum. It is wrong to assume that preferred stock fills a unique demand for an investment security in the market that other securities cannot fill.
Dividends from common stock are as eligible for the dividend-received deduction available to corporate investors as preferred stock. Second, a portfolio of a firm’s debt and common stock can be constructed to have a return that behaves closely to the return on preferred stock. Although preferred stock may appear to a corporate issuer to be more desirable than common stock because of its financial leverage characteristics, this advantage is likely to be illusory.
With the present tax law, preferred stock has no special attributes for which an efficient market would be willing to pay a premium; thus, its cost is not likely to be cheaper than other forms of financing. If the types of risks associated with an investment in common stock and preferred stock purchased individually (not a mixture) are what the market desires and if the risks and returns could not be exactly duplicated in any other way, then it would be possible for a firm with preferred stock outstanding to sell at a premium.
As a theoretical as well as a practical matter, it is unlikely that the investors need the preferred stock to accomplish their investment objectives. If an explanation is to be found for the issuance of preferred stock, it is likely to be found in institutional considerations. The issuing corporation does not have a tax shield with either preferred stock or common stock, so there is no advantage for the corporation issuing preferred stock to be found in the tax laws.
The common stock can give rise to retained earnings (deferring taxes to the investor) and the prospect of capital gains from these retained earnings. The preferred stock does not offer these possibilities; thus, it is at a disadvantage. For zero-tax investors, neither preferred stock nor common stock has any specific advantage for the investor. Debt is likely to be more desirable than either security because of the tax shield provided to the issuer by the interest expense.
- Preferred Stock
Preferred stock is a security that, similar to debt, promises a well-defined (specified) but not necessarily constant contractual cash flow (dividend) to the holders of the security. Unlike debt, it does not cause the firm to be subject to bankruptcy if the dividends are not paid. The term preferred stock...
- Stock Dividend
* A corporate distribution to shareholders declared out of profits, at the discretion of the directors of the corporation, which is paid in the form of shares of stock, as opposed to money, and increases the number of shares.
* A dividend paid as additional shares of stock rather than as...
- Corporate Restructuring
Purpose of Corporate restructuring :
1. To enhance the shareholder value
2. To utilize the assets properly
3. To get profitable investment opportunities
4. To diverse the business
5. To reduce cost of capital by designing innovative securities through corporate restructuring
Types of Corporate...
- Posthorn Corporation
Posthorn Corporation acquired 20,000 of the 100,000 outstanding common shares of Stamp Company on January 1, 2010, for a cash consideration of $200,000 at a time when its shareholders' equity amounted to $1,000,000. The shares of both companies were traded on the national stock exchange. During 2010, Stamp...
- Corporation_ Weekly Reflection
3.1 Differentiate types of stocks issued by corporations.
The team concluded that the different types of stocks issued by a corporation are common stock, preferred stock, and treasury stock. Everyone is aware that common stock gives stockholders the right to vote on actions dealing with corporate earnings...
- Personal Development Plan
I have always been interested in the financial and investment sector. The movements of the stock market and the forces driving the stock values hold considerable degree of interest. I realize that a stockbroker needs to add value to financial information in order to satisfy the customer queries and...
- How Markets and Investors Value Stocks
Collectively, Team B believes stock is a security that shows possession in a company or asset and symbolizes claim from investors or the owner. The market and invests are interested in two types of stocks which are common and preferred. Common stock typically gives a share of ownership in a corporation, to...
- Mini Case Gilbert Enterprise
The firm's stocks are undervalued. According to the dividends, growth rate, and discount rate the share price should be $43. 36 which is $8. 11 higher than the current market price. If the repurchase of $1Million worth of shares occurs, the company's Return on Equity would increase. This would happen since...
- Fundamental Analysis of Banking Stocks
The stock market is the most volatile market and is similar to the weather. Though this does not mean that the markets cannot be predicted but it only means that trends may change without warning, as with weather. The stockmarkets are characterized by almost all factors, again starting right from weather...
- Dividend Yield and Common Equity
Q1: Percy Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company's outstanding bonds is 9% and the company tax rate is 40%. Percy's CFO has calculated the company's WACC as 9.96%. What is the company's cost of common equity? Q2: Tunney Industries issued...