Preference Shares

Unlike common stock, preferred stock usually has several rights attached to it:

• Almost all preferred shares have a negotiated fixed dividend amount. The dividend is usually specified as a percentage of the par value or as a fixed amount
•  The core right is that of preference in the payment of dividends and upon liquidation of the company. Before a dividend can be declared on the common shares, any dividend obligation to the preferred shares must be satisfied
• The dividend rights are often cumulative, such that if the dividend is not paid, it accumulates from year to year
• Preference shares have a claim on liquidation proceeds of a stock corporation, equivalent to its par or liquidation value unless otherwise negotiated. This claim is senior to that of common stock, which has only a residual claim
• Some preferred shares have special voting rights to approve certain extraordinary events (such as the issuance of new shares or the approval of the acquisition of the company) or to elect directors, but most preferred shares provide no voting rights. Some preferred shares only gain voting rights when the preferred dividends are in arrears for a substantial time
• Usually, preferred shares contain protective provisions which prevent the issuance of new preferred shares with a senior claim. Individual series of preferred shares may have a senior, pari-passu or junior relationship with other series issued by the same corporation
• Occasionally, companies use preferred shares as a mean of preventing hostile takeovers, creating preferred shares with a “poison put” or forced exchange/conversion features that are exercised upon a change in control

There are various types of preferred stocks that are common to many corporations:

• Cumulative Preferred Stock – if the dividend is not paid, it will accumulate for future payment
• Non-cumulative Preferred Stock – dividends for this type of preferred stock will not accumulate if they are unpaid. Very common in bank preferred capital, since under BIS capital adequacy requirements, preferred stock must be non-cumulative if it is to be included in Tier 1 capital
• Convertible Preferred Stock – this type of preferred stock carries the option to convert into common stock at a prescribed price
• Participating Preferred Stock – this type of preferred stock allows the possibility of an additional dividend above the stated amount under certain conditions
• Perpetual Preferred Stock – have no fixed date on which invested capital will be returned to the shareholder, although there will always be redemption privileges held by the corporation. Most preferred stock is issued without a set redemption date
• Puttable Preferred Stock – such issues have a “put” privilege whereby the holder may, upon certain conditions, force the issuer to redeem the stock

Ordinary Shares

An ordinary share forms the basic capital of a limited company. As a unit of ownership, shares convey a number of rights to the holder:

1.       Rights of Transfer – of ownership by sale (or gifting).

2.       Dividends – payments made by a company to its shareholders. When a company earns a profit, the cash can be put to two uses: either re-invested in the company (retained earnings), or paid to shareholders of the company as a dividend. Publicly traded companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from a regular one.

3.       Right To Vote – the right to vote at members’ meetings on the major strategic issues of the company. These must be usually held at least annually (in the form of an AGM – Annual General Meeting) and on any major corporate action (e.g. mergers and acquisitions). In most cases, one share carries one voting right.

4.       Rights of Inspection – under normal circumstances, the shareholder has the right to inspect the shareholder list, minutes of shareholders’ general meetings, copies of the directors’ service contracts and various registers maintained by the company.

5.       Liquidation Rights – ordinary shareholders have the right to share in proceeds in the event of the liquidation of the company. However, ordinary shares have the last claim upon liquidation after trade creditors, debt holders and preferred shareholders have been paid.

6.       Pre-emptive Rights (anti-dilution clause) – under UK company law, on the issue of any new shares, the present shareholders must be offered the new shares to allow them to maintain their proportionate ownership in the company. Note that there are many countries, such as the USA, which do not require existing shareholders to receive pre-emptive rights on any new shares.

Understanding the Different Products in the Capital Structure

What is Equity?

Equity capital, or financing, is money raised by a business in return for a share of ownership in the company. It is permanent capital (it does not need to be repaid). Ownership of equity gives the right (but not an automatic entitlement) to share in the profits of the business, after all other stakeholders (employees, debt holders, the taxman) have been paid. Companies are under no obligation to pay dividends, and dividends cannot be offset against tax.

Owning equity is the riskiest form of investment in a company. Ordinary shareholders are the last to be paid in the event of the business failing. As compensation for this risk, equity holders generally earn the highest return. Investors in public listed companies are free to sell their shares without requiring the approval of the company. The returns for investors are a combination of dividends and capital appreciation. 

Introduction to Capital Markets

Introduction

Financing for governments and corporations was originally dominated by a bilateral relationship between borrower and bank. As economies and companies grew, there was a need to raise larger and larger amounts of finance and with this came the need to distribute the risks that had become too large for a single bank.

The capital markets have become the means to achieve this diversification by allowing the issuance of tradable debt and equity securities by companies and governments. Initially, these markets had a physical nature but they have increasingly become “de-materialised”, becoming either an electronic trading system or even just a web of interested parties. The capital markets are generally regulated by institutions such as the Securities and Exchange Commission in the US and the Financial Services Authority in the UK, but the international and virtual nature of these markets poses a constant challenge to national regulators.

 

The market can be divided into primary and secondary. The primary market is where new issues in debt or equity are arranged by investment or universal banks. New equity issues are rarer than new debt issues and once launched, will generally trade on a recognised stock exchange such as the New York or London Stock Exchange.

Debt capital markets are more diverse and include the money markets where short-term loans and deposits are traded, the foreign exchange market where currencies are bought and sold, and the long‑term debt market where bonds are bought and sold. While there is no central market such as a stock exchange for the debt markets, the debt markets will have similar infrastructure such as settlement systems, trading conventions and inter-dealer brokers.

The debt capital markets have become far more important in the last 30 years, as the role of banks has shifted from the conventional “lend and hold” approach to a model whereby banks originate loans and distribute them on the capital markets. The final holders of the securities include insurance companies, pension funds and individuals.