What Is Capital Preferred Stock?
Capital preferred stock is a type of equity security that represents ownership in a company, distinguished by its preferential rights over common stock regarding dividends and asset distribution upon liquidation. It occupies a unique position within a company's capital structure, often viewed as a hybrid security combining features of both bonds and common equity. This makes it a key instrument in corporate finance for raising capital. Holders of capital preferred stock typically receive fixed dividends before common shareholders and have a higher claim on company assets in the event of bankruptcy, though they usually lack voting rights. The concept of capital preferred stock is designed to appeal to investors seeking a balance between stable income generation and a degree of ownership.21
History and Origin
The origins of preferred stock, which forms the basis of capital preferred stock, trace back to the mid-19th century in the United States. Early corporations sought ways to raise capital that offered investors more security than common stock while maintaining some flexibility for the issuing company. This led to the development of a security that provided a fixed income stream and a preferential claim on assets. Over time, preferred stock became a common investment vehicle, especially for large public utilities and transportation companies, becoming widely adopted by the 1920s as a means of financing growth and operations. Today, companies continue using preferred stock to raise capital, particularly within the financial sector.20
Key Takeaways
- Capital preferred stock offers fixed dividend payments that typically take precedence over common stock dividends.19
- In the event of a company's liquidation, preferred stockholders have a higher claim on assets than common stockholders, but are subordinate to bondholders.18
- Unlike common stock, capital preferred stock usually does not carry voting rights, meaning preferred shareholders have limited influence on corporate governance.17
- It is considered a hybrid security, blending characteristics of both debt (fixed payments) and equity (ownership stake).16
- The price of capital preferred stock tends to be less volatile than common stock, making it attractive for investors focused on income generation.15
Formula and Calculation
The annual dividend payment for capital preferred stock is typically calculated based on its par value and a stated dividend rate.
Annual Preferred Dividend = Par Value per Share × Dividend Rate
For example, if a capital preferred stock has a par value of $100 and a dividend rate of 5%, the annual dividend per share would be:
Annual Preferred Dividend = $100 × 0.05 = $5
The dividend yield, which expresses the annual dividend as a percentage of the current market price, can be calculated as:
This calculation helps investors understand the return on their investment relative to the stock's market price, providing a metric for comparison with other fixed income investments.
14## Interpreting the Capital Preferred Stock
Interpreting capital preferred stock involves understanding its position within a company's financing structure and its implications for investors. The "capital" aspect often refers to its role in a company's overall capital structure, particularly its contribution to a company's total equity. For investors, the fixed dividend and preferential claim in liquidation signify a lower risk management profile compared to common stock, albeit with typically less potential for capital appreciation. The absence of voting rights means investors are primarily focused on income and capital preservation rather than influencing corporate decisions. Companies often issue capital preferred stock to raise funds without diluting the voting power of existing common shareholders.
13## Hypothetical Example
Consider "Alpha Corp" decides to issue 1 million shares of capital preferred stock with a par value of $25 per share and an annual dividend rate of 6%. An investor, Sarah, purchases 100 shares of this capital preferred stock at its par value.
- Total Investment: 100 shares × $25/share = $2,500
- Annual Dividend per Share: $25 (par value) × 0.06 (dividend rate) = $1.50
- Total Annual Dividend for Sarah: 100 shares × $1.50/share = $150
If Alpha Corp faces financial difficulties in a given year and cannot pay dividends to both preferred and common shareholders, the holders of capital preferred stock, including Sarah, would receive their $1.50 per share dividend before any dividends are paid to common stockholders. This demonstrates the preferential nature of capital preferred stock.
Practical Applications
Capital preferred stock is widely utilized by corporations, especially those in capital-intensive industries or the financial sector, as a means of raising funds. For 12instance, banks and insurance companies frequently issue preferred stock to meet regulatory capital requirements. This allows them to strengthen their balance sheet and support liabilities. Inve11stors value capital preferred stock for its predictable income stream, which makes it suitable for portfolios aiming for consistent returns. It can also be a strategic tool for companies looking to raise equity financing without significantly altering their debt-to-equity ratio or diluting the voting control of common shareholders. The reasons for issuing preferred shares are varied but generally center on achieving specific financing goals while appealing to a segment of investors seeking a blend of income and stability.
Limitations and Criticisms
Despite their advantages, capital preferred stock carries certain limitations and criticisms. A primary drawback is the typically limited potential for capital appreciation; unlike common stock, the price of preferred stock is less likely to experience significant long-term growth. They9, 10 are also sensitive to interest rate changes; when interest rates rise, the value of existing capital preferred stock tends to fall, similar to bonds, due to the fixed nature of their dividends.
Another significant risk is the call feature common to many preferred issues, which allows the issuing company to repurchase the shares at a predetermined price after a certain date. This means investors might have their shares redeemed when interest rates fall, forcing them to reinvest at a lower yield. While preferred dividends are prioritized, they are not guaranteed. A company facing severe financial distress may suspend dividend payments, as observed with First Republic Bank during a challenging period in 2023, which announced the cancellation of preferred dividends. This8 highlights that while they offer a preferential claim, preferred stockholders are still subordinate to creditors and bondholders in the capital stack.
Capital Preferred Stock vs. Common Stock
Capital preferred stock and common stock both represent ownership in a company, but they differ significantly in their rights and characteristics.
| Feature | Capital Preferred Stock | Common Stock |
|---|---|---|
| Voting Rights | Generally none or limited | Typically one vote per share, influencing company decisions |
| 7Dividends | Fixed, preferential, paid before common stockholders | Variable, not guaranteed, paid after preferred stockholders |
| Claim on Assets | Higher priority in liquidation than common stockholders, but subordinate to bondholders | La6st in line during liquidation, after creditors, bondholders, and preferred stockholders |
| Capital Gains | Limited potential for price appreciation | Higher potential for price appreciation based on company growth |
| 5Volatility | Generally less volatile due to fixed dividends | More volatile, fluctuating with company performance and market conditions |
| 4Hybrid Nature | Considered a hybrid investment, blending debt and equity characteristics | Pu3re equity instrument, representing residual ownership |
Common stockholders participate more directly in the potential growth and decision-making of a company, while capital preferred stockholders prioritize stable income and a more secure claim on assets.
2FAQs
Are dividends on capital preferred stock guaranteed?
No, dividends on capital preferred stock are not guaranteed. While preferred shareholders have a preferential claim to dividends before common shareholders, a company's board of directors can choose to suspend dividend payments if the company faces financial difficulties. If the preferred stock is cumulative, unpaid dividends will accrue and must be paid before any common dividends can be distributed in the future.
Do preferred stockholders have voting rights?
Typically, holders of capital preferred stock do not have voting rights in corporate governance matters, such as electing board members or approving major corporate actions. This is a key difference from common stock, which usually carries voting rights. However, some preferred stock agreements may grant limited voting rights, particularly if dividend payments are in arrears.
Is capital preferred stock a debt or an equity instrument?
Capital preferred stock is considered a hybrid security because it possesses characteristics of both debt and equity. Like debt, it often pays fixed income payments (dividends) and may have a par value. Like equity, it represents an ownership stake in the company and is listed on the company's balance sheet under shareholders' equity.
###1 Why do companies issue capital preferred stock?
Companies issue capital preferred stock for several reasons, including raising capital without diluting the voting power of common shareholders, maintaining a lower debt-to-equity ratio compared to issuing bonds, and appealing to investors who seek steady income and a preferential claim on assets. It provides a flexible financing option for companies needing capital but wishing to avoid certain obligations associated with traditional debt.