9.4 Preference shares

Question 1

What are preference shares?

Answer 1

Share carrying preferential rights over the ordinary shares on profits available.

Question 2

Why may preference shares be treated as debt rather than equity for the purposes of accounting?

Answer 2

Because they carry a fixed rate of dividend.

Question 3

What is a cumulative preference share?

Answer 3

A share which accumulates its annual fixed rate dividend if it cannot be paid in a given year.

Question 4

What is a redeemable preference share?

Answer 4

A share which can be purchased back (redeemed) by the company.

Question 5

What is a “participating” preference share?

Answer 5

A share which entitles the shareholder not only to a fixed rate of dividend, but also to a share in surplus profits.

Question 6

What is a “convertible” preference share?

Answer 6

A preference share that may be converted to equity shares at a future date.

Question 7

What are the advantages of preference shares?

Answer 7

• dividends are only payable if there are sufficient distributable profits available (unlike a fixed interest loan where interest must be paid regardless).
• no loss of control as preference shares do not carry a vote
• unlike debt, shares are not secured over a company’s assets

Question 8

What are the disadvantages of preference shares?

Answer 8

• dividends are not tax allowable - debt is more tax advantageous
• preference shares require a higher rate of interest than debt due to extra risk for shareholders
• on liquidation, preference shares rank before ordinary shares of a company