Preference shares are shares in the equity of a company that entitle the holder to a fixed dividend amount to be paid by the issuer. This dividend must be paid before the company can issue any dividends to its common shareholders. Also, if the company is dissolved, the owners of preference shares are paid back before the holders of common stock. However, the holders of preference shares do not usually have any voting control over the affairs of the company, as do the holders of common stock.
The types of preference shares are:
- Callable. The issuing company has the right to buy back these shares at a certain price on a certain date. Since the call option tends to cap the maximum price to which a preference share can appreciate (before the company buys it back), it tends to restrict stock price appreciation.
- Convertible. The owner of these preference shares has the option, but not the obligation, to convert the shares to a company's common stock at some conversion ratio. This is a valuable feature when the market price of the common stock increases substantially, since the owners of preference shares can realize substantial gains by converting their shares.
- Cumulative. If a company does not have the financial resources to pay a dividend to the owners of its preference shares, then it still has the payment liability, and cannot pay dividends to its common shareholders for as long as that liability remains unpaid.
- Non-cumulative. If a company does not pay a scheduled dividend, it does not have the obligation to pay the dividend at a later date. This clause is rarely used.
- Participating. The issuing company must pay an increased dividend to the owners of preference shares if there is a participation clause in the share agreement. This clause states that a certain portion of earnings (or of the dividends issued to the owners of common stock) will be distributed to the owners of preferences shares in the form of dividends.
Preference shares are the same as preferred stock. The term "preference shares" is more commonly used in Europe.