Table of Contents
Preference shares are those which carry priority rights with regard to the payment, of dividends and return of capital and at the same time are subject to certain limitations with regard to voting rights.
The preference shareholders are entitled to receive the fixed rate of dividend out of the net profit of the company. Only after the payment of dividends at a fixed rate is made to the preference shareholders, the balance of profit will be used for paying dividends to ordinary shares.
The rate of dividends on preference shares is mentioned in the prospectus. Similarly, in the event of liquidation, the assets remaining after payment of all debts of the company are first used for returning the capital contributed by the preference shareholders.
The advantages of preference shares are explained below:
- Preference shares have the merits of equity shares without their limitations.
- The issue of preference shares does not create any charge against the assets of the company.
- The promoters of the company can retain control over the company by issuing preference shares since the preference shareholders have only limited voting rights.
- In the case of redeemable preference shares, there is the advantage that the amount can be repaid as soon as the company is in possession of funds flowing out of profits.
- Preference shares are entitled to a fixed rate of dividend and the company may declare higher rates of dividend for the equity shareholders by training on equity and enhancing market value.
- If the assets of the company are not of high value, debenture holders will not accept them as collateral securities. Hence the company prefers to top market with preference shares.
- The public deposit of companies in excess of the maximum limit stipulated by the Reserve Bank can be liquidated by issuing preference shares.
- Preference shares are particularly useful for those investors who want a higher rate of return with comparatively lower risk.
- Preference shares add to the equity base of the company and they strengthen the financial position of it. An additional equity base increases the ability of the company to borrow in the future.
- Preference shares have variety and diversity, unlike equity shares. Companies have thus flexibility in choice.
The following are the disadvantages of preference shares:
- Usually, preference shares carry a higher rate of dividend than the rate of interest on debentures.
- Compared to debt capital, preference share capital is a very expensive source of financing because the dividend paid to preference shareholders is not, unlike debt interest, a tax interest, a tax-deductible expense.
- In the case of cumulative preference shares, arrears of dividends accumulate. It is a permanent burden on the profits of the company.
- From the investor’s point of view, preference shares may be disadvantageous because they do not carry voting rights. Their interest may be damaged by equity shareholders in whose hands the control is vested.
- Preference shares have no attraction to investors, however. Not even 1 percent of total corporate capital is raised in this form in India.
- Instead of combining the benefits of equity and debt, preference share capital perhaps combines the banes of equity and debt.