Question

What are the features and characteristics of preferred stocks and common stocks? Why does Netscape’s senior management team find convertible preferred stocks more attractive than high salaries?

Answer 1

Features and characteristics of preferred stocks and common stocks

Preferred Stock

• Preferred stock has characteristics of both common stock and a bond. It is sometimes referred to as a hybrid security.
• Preferred stock gives the shareholder an ownership position in the company; like bonds, preferred stock usually doesn't have voting rights.
• Preferred stock is typically issued with a fixed dividend; this is similar to a bond's interest rate, but like common stock, preferred stock dividends are not guaranteed.
• Preferred stock might include a number of other variables, such as a redemption date, convertible features and call provisions. Preferred stockholders have precedence over common stockholders in the event of a company liquidation.
• The board of directors can vote to suspend preferred dividend payments, but all preferred dividends, including any missed dividend payments, must be paid before the company can pay any dividends on its common stock.
• Preferred stock typically includes a call provision, which allows your company to repurchase the stock on demand for a fixed price. This allows you to take advantage of falling interest rates by calling the preferred stock, then reissuing new preferred shares at a lower fixed dividend rate that corresponds to prevailing interest rates. If prevailing interest rates rise, you have the advantage of being able to continue paying dividends at the lower fixed rate.

Common Stock

• Common stock represents ownership in a company, and each share of common stock holds an equal amount of that ownership.
• Common stock grants the stockholders certain rights, which typically include the right to sell the stock in the secondary market, either through a public exchange or in a private transaction.
• Stockholders have the right to participate in the profits of the company through dividend payments, when such dividends are authorized by the company board of directors. They have the right to vote at the annual stockholders' meeting, and they have the right to the company's remaining assets if the company goes out of business.
• When you raise money for your company by issuing common stock, you don't incur any debt. You have no obligation to pay dividends, so your board of directors can decide to plow all of your company's profits back into growing the company. Any time you sell stock in your company, you dilute your ownership position. If you sell more than 50 percent of your company's stock, you risk losing control of your company.

Why does Netscape’s senior management team find convertible preferred stocks more attractive than high salaries?

• Convertible preferred stock gives an investor a stream of income (dividends on the preferred stock) as well as potential 'upside' advantages.
• It can be converted into the common stock of the company at the predetermined date and conversion ratio. Investors find this to be an attractive feature of a preferred stock.
• The value of the shares you obtain by converting a preferred share is equal to the common stock's market price multiplied by the conversion ratio. The conversion premium percentage is the difference between the preferred share's parity value and its conversion value, divided by the parity value.
• A potential investor may require some additional protection and/or additional compensation for his investment by requiring the preferred stock to be convertible. Convertible preferred stock can be exchanged for the common stock of the company if certain conditions are met. The contractually set conversion ratio determines the number of common shares each share of preferred stock may be converted into.

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