Preferred stock, also called preferred shares (preferred), is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument. These are senior (i.e. higher ranking) to common stock, but are subordinate to bonds.
Preferred stock usually carries no voting rights, but may carry a dividend and may have priority over common stock in the payment of dividends and upon liquidation. Preferred stock may have a convertibility feature into common stock. Terms of the preferred stock are stated in a "Certificate of Designation". Similar to bonds, preferred stocks are rated by the major credit rating companies. The rating for preference shares is generally lower since preferred dividends do not carry the same guarantees as interest payments from bonds and they are junior to all creditors.
Types of preferred stock include:
Cumulative and non-cumulative preference shares * Cumulative preferred stock— If the dividend is not paid, it will accumulate for future payment. Non-cumulative preferred stock—Dividend for this type of preferred stock will not accumulate if it is unpaid. Very common in bank preferred stock, since under BIS rules, preferred stock must be non-cumulative if it is to be included in Tier 1 capital.
Participating and non-participating preference shares * Participating Preferred Stock—These preferred issues offer the holders the opportunity to receive extra dividends if the company achieves some predetermined financial goals. The investors who purchased these stocks receive their regular dividend regardless of how well or how poorly the company performs, assuming the company does well enough to make the annual dividend payments. If the company achieves predetermined sales, earnings or profitability goals, the investors receive an additional dividend.
Redeemable and non-redeemable preference shares * Redeemable Preference