8.5 Summary

Summary

In this chapter, we discussed the following aspects of common and preferred shares:

• Benefits of Common Share Ownership: These can include:

  • Capital Appreciation: The value of common shares can increase over time, providing an opportunity for capital gains.
  • Dividend Income: Companies may distribute a portion of their profits to shareholders in the form of dividends.
  • Voting Privileges: Shareholders often have the right to vote on important company matters such as electing the board of directors.
  • Favourable Tax Treatment: In some jurisdictions, dividends received by shareholders may be taxed at a lower rate than other forms of income.
  • Easy Marketability: Common shares are traded on stock exchanges, providing liquidity to investors.
  • Access to the Board of Directors: Shareholders can influence the company’s strategy and policies by voting on board members.
  • Limited Liability: Shareholders are not personally liable for the company’s debts beyond their investment in the company’s shares.

• Stock Splits and Consolidations:

  • Stock Split: A stock split increases the number of shares outstanding, which can make shares more affordable to smaller investors.
    • Example: A 2-for-1 stock split will double the number of shares while halving the price per share.
  • Consolidation (Reverse Split): A consolidation reduces the number of shares outstanding, which can raise the per-share price.
    • Example: A 1-for-2 consolidation will halve the number of shares but double the price per share.
  • In both cases, the market price changes, but the overall value of the investors’ ownership remains unchanged.

• Preferred Shareholders’ Rights:

  • Liquidation Preference: In event of liquidation, preferred shareholders rank below the company’s creditors but above common shareholders.

• Why Investors Buy Preferred Shares:

  • Income Flow: Preferred shares provide regular income through dividend payments.
  • Preferential Tax Treatment: Dividends from preferred shares may enjoy favourable tax rates compared to other income types.

• Why Companies Issue Preferred Shares Rather Than Bonds:

  • Unfavorable Market Conditions: When the market is unreceptive to new debt.
  • High Debt-to-Equity Ratio: When a company’s existing debt levels are too high.
  • Avoid Legal Obligations of Debt: Bonds create legal obligations; preferred shares do not.
  • Feasibility Under Tax Conditions: Preferably in situations where paying dividends from after-tax profits is more tax-efficient.

• Callable vs. Non-Callable Preferred Shares:

  • Callable Preferred Shares: Issuers can redeem them at a predetermined time and price.
  • Non-Callable Preferred Shares: Cannot be redeemed as long as the company exists.

• Types of Preferred Shares:

  • Straight Preferred Shares: Have fixed dividend rates and preference in asset and dividend entitlement.
  • Convertible Preferred Shares: Allow the holder to convert into common shares at a predetermined price and period.
  • Retractable Preferred Shares: Shareholders can compel the company to repurchase at specified dates and prices.
  • Floating Preferred Shares: Dividends fluctuate based on interest rate changes.
  • Foreign-Pay Preferred Shares: Dividends are paid in or tied to foreign currencies.
  • Participating Preferred Shares: Have rights to additional earnings beyond the specified dividend.
  • Deferred Preferred Shares: Dividends are paid upon maturity.

Frequently Asked Questions

1. What is the difference between common and preferred shares?

   • Common shares provide voting rights and potential for capital gains but are riskier. Preferred shares offer fixed dividends and higher claim on assets but usually don’t carry voting rights.

2. How does a stock split affect my investment?

   • A stock split increases the number of shares you own but reduces the price per share, leaving the overall value of your investment unchanged.

3. Why would a company issue preferred shares instead of taking on more debt?

   • Issuing preferred shares helps maintain a healthier debt-to-equity ratio, avoids legal debt obligations, and can be more favorable under certain tax conditions.

Key Takeaways

• Common shares offer benefits like capital appreciation, dividend income, voting rights, and favourable tax treatment.
• Stock splits and consolidations alter share count and price but not the investor’s total holding value.
• Preferred shares come with specific rights and are issued for reasons such as avoiding additional debt or leveraging tax advantages.
• Various types of preferred shares, including callable, convertible, and floating-rate shares, provide different features and benefits to cater to diverse investor needs.

Feel free to refer to the Chapter 8 Review Questions for self-assessment, or consult the online Chapter 8 FAQs for additional queries.