Question

Question 4:

a) Explain the difference between preference shares and ordinary shares.

Answer 1

Ordinary Shares vs Preference Shares

A share denotes a claim on a corporation’s ownership or interest in a financial asset. Shares are commonly divided into two types, known as ordinary shares and preference shares. Ordinary shares and Preference shares are distinguished from each other based on the benefits, rights and features that they offer to the holders of such shares. This article will guide the reader through the many attributes that differentiate them.

Ordinary shares

An ordinary share defines a single unit of equity ownership of a corporation, where the holders of the ordinary shares receive the right to cast a vote in decisions involving important corporate matters. Such votes are available to each ordinary shareholder in correspondence to the number of ordinary shares held within the company. Ordinary shareholders are the last to receive dividends, and are only entitled to funds which remain after dividends on preferred shares are paid. Ordinary share holders may not receive dividend payments every year, and payments to ordinary shareholders depend on reinvestment decisions made by the company directors. In an event of the company facing liquidation, the ordinary shareholders will be the last to receive their share of funds, after the creditors and preference shareholders are paid. As such ordinary shares are riskier than bonds or preference shares. Ordinary shares are also referred to as ‘common stock’.

What is Preference Shares

A preference share contains features of equity and debt as the dividend payments to preference shareholders are fixed. The types of preference shares include cumulative preference shares – in which dividends including those in arrears from past terms are also paid, non-cumulative preference shares – where the missed out dividend payments are not carried forward, participating preference shares are where the holder receives dividends and any additional funds in times of financial stability, and convertible preference shares is where an option is available to convert shares into ordinary shares. Preference shares are offered preference in relation to ordinary shares, where the preference shareholder receives dividends before ordinary shareholders are paid out. Preference shareholders are paid a fixed dividend and have the first claim on the assets and earnings. As such, preference shareholders receive their share of the firm’s residual value before ordinary shareholders in the event of liquidation. Preference shareholders do not have voting rights.

What is the difference between Ordinary Shares and Preference Shares?

Both ordinary and preference shares illustrate a claim in the corporate earnings and assets. Dividends for ordinary shares may be irregular and indefinite, whereas preference shareholders will receive a fixed dividend which will accrue usually if the payments are not made in one term. Ordinary shareholders are in a riskier position than preference shareholders since they are the last to receive their share in the event of liquidation; however, they also are open to the possibility of a higher dividend during times when the firm is doing well. The ownership of preference shares offer advantages and disadvantages in terms of higher claims on earnings and assets and fixed dividends as opposed to limited voting rights and limited possibility for growth in dividends in times when the company is financially sound.