Preference shares—shares with a fixed rate of dividend which have a prior claim on profits available for distribution.
Preference shares, which are also called "preferred shares", are legally equity. They are often treated as debt (e.g. under
International Financial Reporting Standards) as they are similar in nature to debt.
Some of the common features found for preference shares include:
The shares have a fixed percentage dividend payable before ordinary dividends. This preference share dividend is expressed as a percentage of par value.
The dividend is only payable if there are sufficient distributable profits. If the shares are cumulative preference shares, however, the right to receive dividends which were not paid is carried forward (this is known as cumulative preference dividends). Any arrears of dividend are then payable before ordinary dividends.
As with ordinary dividends, preference dividends are not deductible for corporate tax purposes. The preference dividends are considered a distribution of profit rather than an expense.
On liquidation of the company, preference shareholders rank before ordinary shareholders and after debt holders.
---No voting rights; therefore no dilution of control.
---Compared to the issue of debt:
preferred dividends do not have to be paid in any specific year, especially if profits are poor;
preferred shares are not secured on company assets; and
non-payment of dividend does not give holders the right to appoint a liquidator.
---Preferred dividends are not tax deductible (unlike interest on debt).*
---To attract investors to buy preferred shares, the company needs to pay a higher return to compensate for the additional risk compared to debt.