Companies can attract funding through the issuance of shares, either privately or on public exchanges. Investors who buy a share become the legal owner of part of the company. Therefore, these investors have a claim on the company’s assets and profits generated from those assets. Investors can generate a return from owning shares either through the payment of dividends, share price increases or both depending on the strategy the company is pursuing. We should mention that any future profits, dividends, and share price increases are uncertain. This is in contrast to the interest payments on a bond. Also, in case of a bankruptcy, shareholders only have a residual claim. This means that they only get part of the value back that is left after all other creditors have been repaid. Shares are thus obviously riskier than bonds.
Most stocks issued by companies are common shares. They have all of the above described characteristics. Additionally, the owner of the shares has a voting right on the shareholders’ annual meeting.
Preferred shares differ from common shares in various ways. First, in the case of a dividend distribution, they are paid before the common shareholders. This thus gives the owner of the preferred shares a higher degree of certainty towards the dividend return on his investment. Moreover, preferred shares often receive a dividend yield which is higher than the dividend yield for common shareholders Second, in the case of a bankruptcy, preferred shareholder get their money back (if any) before the common shareholders. The probability of losing the whole investment is thus smaller. Finally, preferred shareholders may not be attributed any voting rights on the shareholders annual meeting, although this is not always the case.
Shareholders have a claim on the company’s assets and profits. Their return is uncertain and therefore they bear more risk. Common and preferred shares have different characteristics and (dis)advantages.