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Preferred shares are more common in private or pre-public companies, where it is useful to distinguish between the control of and the economic interest in the company. Government regulations and the rules of stock exchanges may either encourage or discourage the issuance of publicly-traded preferred shares. In many countries, banks are encouraged to issue preferred stock as a source of Tier 1 capital. On the other hand, the Tel Aviv Stock Exchange prohibits listed companies from having more than one class of capital stock.
A company may issue several classes of preferred stock. It may undergo several rounds of financing, with each round receiving separate rights and having a separate class of preferred stock. Such a company might have "Series A Preferred," "Series B Preferred," "Series C Preferred" and common stock.
In the United States there are two types of preferred stocks: straight preferreds and convertible preferreds. Straight preferreds are issued in perpetuity (although some are subject to call by the issuer, under certain conditions) and pay a stipulated rate of interest to the holder. Convertible preferreds—in addition to the foregoing features of a straight preferred—contain a provision by which the holder may convert the preferred into the common stock of the company (or, sometimes, into the common stock of an affiliated company) under certain conditions (among which may be the specification of a future date when conversion may begin, a certain number of common shares per preferred share or a certain price per share for the common stock).
There are income-tax advantages generally available to corporations investing in preferred stocks in the United States. See Dividends received deduction.
But for individuals, a straight preferred stock, a hybrid between a bond and a stock, bears some disadvantages of each type of securities without enjoying the advantages of either. Like a bond, a straight preferred does not participate in future earnings and dividend growth of the company, or growth in the price of the common stock. However, a bond has greater security than the preferred and has a maturity date at which the principal is to be repaid. Like the common, the preferred has less security protection than the bond. However, the potential increase in the market price of the common (and its dividends, paid from future growth of the company) is lacking for the preferred. One advantage of the preferred to its issuer is that the preferred receives better equity credit at rating agencies than straight debt (since it is usually perpetual). Also, certain types of preferred stock qualify as Tier 1 capital; this allows financial institutions to satisfy regulatory requirements without diluting common shareholders. Through preferred stock, financial institutions are able to gain leverage while receiving Tier 1 equity credit.
If an investor paid par ($100) today for a typical straight preferred, such an investment would give a current yield of just over six percent. If, in a few years, 10-year Treasuries were to yield more than 13 percent to maturity (as they did in 1981) these preferreds would yield at least 13 percent; this would reduce their market price $46, a 54-percent loss. The difference between straight preferreds and Treasuries (or any investment-grade Federal-agency or corporate bond) is that the bonds would move up to par as their maturity date approaches; however, the straight preferred (having no maturity date) might remain at these $40 levels (or lower) for a long time.
Advantages of straight preferreds may include higher yields and tax advantages; they yield about 2 percent more than 10-year Treasuries, rank ahead of common stock in case of bankruptcy and dividends are taxable at a maximum rate of 15% rather than at ordinary-income rates (as with bond interest).
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