Preferred Stock is a class of ownership inside a corporation with a higher claim around the assets and cash flow than common stock. It is a share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends. It generally features a dividend that must definitely be paid out before dividends to common stockholders and also the shares tend not to have voting protection under the law.
Disadvantages of preferred stock financing from Company’s viewpoint are as follows:
(1) Preferred stock financing is expensive source of long-term financing because of two reasons:
- The dividend rate on preferred stock is higher than the interest rate payable on debentures.
- Unlike interest, preferred stock dividend is not tax-deductible expenses.
(2) The preferred stock dividend is fixed and the company must have the commitment to pay this dividend. Although preferred stock dividends can be omitted, they may have to be paid because of their cumulative nature. Thus, preferred dividends are like fixed costs. The use of preferred stocks,like that of debt, increases financial risk and thus cost of common equity.
(3) It is difficult to sell preferred stock in the market. Investors may not like to invest on preferred stocks because they get only fixed amount of dividend even though firm’s earning is too high. Besides, if the earning of firm is low or unstable investors may not get preferred dividend. Hence, it is difficult to sell the stocks.
(4) Preferred Stock is difficult to sell in the market investors may not like to invest in preferred stocks because they get only a fixed the amount of dividend even though firms earning is too high. Besides, if the earning of the firm is low or unstable investors may not get the preferred dividend. Hence, it is difficult to sell the stocks.