Preferred stock and Common stock

Preferred stock

Preferred stock represents the long term source of financing under which the stockholders are entitled to get fixed amount of dividend out of the earning of the company after payment of debenture interest and tax.

Preferred stock, also called preference share, is a hybrid form of long term financing with combined features of both common stock and long term debenture. As in the case of common stock the nonpayment of preference dividend doesn’t force the company to insolvency. Dividends cannot be deducted for tax purpose i.e, they have no maturity date. Now, similar to debentures, fixed rate of dividend is paid and generally, preference shareholders have no voting right. But preference shareholders have claims on income and assets prior to common stockholders except that of creditors.

Preference dividend is discretionary. Failure to pay such dividend will not result to default of company’s obligation or insolvency of the company. Hence, if needs be, the board of directors may postpone or omit such dividend because treatment of preferred stock dividend as a fixed obligation increases the explicit cost of the company. Hence preferred stocks are less risky than bonds from the corporations point of view

Dividend does not have to be paid if profit is not earned.

Nonpayment of preferred dividend will not bankrupt the firm.

Characteristics of common stocks

Common stock is an ownership share in a corporation. Common stock certificates are legal documents that evidence ownership in a company that is organized as a corporation; they are also marketable financial instruments. Sole proprietorship and partnership are other forms of business organizations, but only corporations can issue common stocks.

Common stock is the recipient of the residual income of the corporation. Though the right to vote, holders of common stock have a legal control over the corporation. An element of risk is also involved in equity ownership due to its low priority of claim at liquidation. Common stockholders have limited liability. Common equity provides a cushion for creditors if losses occur on dissolutions. The equity-to-total-assets ratio is an indicator of the degree by which the amount realized on the liquidation may decline from the stated book value before creditors suffer losses.