Question

We should discuss Preferred Stock. What makes stock common or preferred? It is the preferences on the stock that make that class of stock preferred.

Most preferred stocks prohibit the firm from paying common dividends when the preferred is in arrears;usually cumulative up to a limit.
Some preferred stock is perpetual, but most new issues have sinking fund or call provisions which limit maturities.
Preferred stock has no voting rights, but may require companies to place preferred stockholders on the board (sometimes a majority) if the dividend is passed.
Is preferred stock closer to debt or common stock? What is its risk to investors? To issuers?

What are some of the advantages and disadvantages or preferred stock?
Advantages
Dividend obligation not contractual
Avoids dilution of common stock
Avoids large repayment of principal
Disadvantages
Preferred dividends not tax deductible, so typically costs more than debt
Increases financial leverage, and hence the firm’s cost of common equity

Answer 1

Preferred stock is hybrid security that has the characteristics of both debt and equity. Similar to fixed income securities preferred stock paya preferrred shareholders a fixed periodic preferred dividend. Like equity, preferred stcokrepresents an ownership investment that does not generally require the return of the principal.

Risk to investors:

Preferred stock being a hybrid debt can be suspended from time to time. Profitability is required to pay out the dividends. Any omitted payments are accumulated and made up for later. Thus, a steady cash flow is not always guaranteed.

Risk to issuers:

In liquidation and bankruptcy proceedings, preferred stock acquire the rights of creditors.For preferred stock, dividend expense is paid after using after tax profit. So tax savings on interest expense makes debt financing less expensive than preferred stock financing. After years of making losses, if a company makes profits, the accumulted preference dividend will have to be paid out first thus diminishing cash flows.

*Advantages and disadvantages are already listed out.