Question

4. The preferred response will include an explanation in your own words, and a good example.

From the point of view of an issuing corporation, please describe the primary advantages and disadvantages of issuing preferred stock.

Answer 1

From the issuing entity's perspective, the prime benefit of issuing preferred stock would be:

- Preference Shares do not have voting rights, thereby ensuring that issuance of preferred equity will not dilute the company's ownership in the way done by common equity issue.

- Preference Shares on account of paying (promising) a fixed income to investors possess less risk as compared to common equity. Therefore, issuing preferred equity has less cost as compared to common equity.

- Preference Shares pay fixed income only when the company makes a profit. Therefore, the issuing corporation enjoys the advantage of not paying preferred dividends when the company is in the red. However, if the preferred equity is issued with an accumulation clause, then all outstanding preferred dividends are accumulated till the company goes back into profit and pays back all its outstanding preferred dividend then.

- Callable preferred shares provide issuing corporations with the option to repurchase shares once conditions apt for a lower dividend.

The prime disadvantage of issuing preferred equity is that its cost is greater than that of debt. Further, unlike debt preferred equity does not carry an interest tax shields.