Preference sharesperspective, than are ordinary shares. Investors’ expectations of returns from preference
shares are therefore lower than expectations from ordinary shares in the same busi-
ness. Historically, preference shares have been a significant source of corporate finance.
More recently they seem to have fallen from favour and have tended to be of neg-
ligible importance as a source of new finance. Many businesses are still partly financed
by preference shares issued some years ago, however.
Preference shares are usually cumulative. This means that if the preference dividend
is not met in full in any particular year, ordinary shareholders are not entitled to
dividends in any future year until preference share dividends have been brought up
to date.Nominal value
Preference shares have a nominal value but, as with ordinary shares, its size is not usu-
ally of much importance. However, the preference dividend is usually expressed as a
percentage of the nominal value (though it need not be).Investors’ ratios
Dividend yield and dividend cover are important ratios to the preference shareholder.
Dividends would normally be by far the most significant part of the preference shares’
returns, so the effective rate and its security are important matters.Factors for the business to consider on preference share financing
Issue costs
Issue costs are similar to those associated with raising new equity finance and sim-
ilarly variable with the method used.Servicing costs
Servicing costs tend to be lower than those relating to ordinary shares, since prefer-
ence shares expose their holder to rather less risk.Obligation to pay dividends
Preference shares do not impose on the business the legal obligation to pay a dividend.
They do, however, impose the obligation to meet the preference dividend before any
dividend may be paid to ordinary shareholders. Where preference shares are cumulat-
ive, arrears of unpaid preference dividends must also be made good before ordinary
shareholders may participate in dividends. In practice, despite the lack of legal obliga-
tion, businesses seem reluctant to miss paying a preference dividend.Obligation to redeem preference shares
Some preference shares are expressly issued as redeemable, and where this is the case
the business must be mindful of the necessity to finance this redemption. By no means
all preference shares are redeemable, and, where they are not, the position is similar
to that with ordinary shares. Where preference shareholders cannot demand redemp-
tion, this type of financing is a relatively safe one from the ordinary shareholders’
viewpoint.