Manag., January-2017-Q18
0. Which one of the following is not a feature of ‘Preference Shares’?
- Option : C
- Explanation : As the name indicates, preference shares are the shares of a firm with preferential treatment compared to ordinary equity shares. As a
source of long-term finance, preference shares are given preference in payment of dividends and also preference in distribution of assets
in case of liquidation of the firm. Section 85 of the Companies Act 1956 defines preference shares as having the following two
characteristics:
(i) These shares have preferential right to be paid dividend at a fixed rate; and
(ii) These shares have preferential right to the return of capital in case of liquidation.
Features/Attributes
The main attributes of preference shares/ capital are discussed below.
Prior Claim on Income/Assets : Preference share/capital has a prior claim/preference over equity share/capital both on the income and assets of the company. In other words, preference dividend must be paid in full before payment of any dividend on the equity capital and, in the event of liquidation, the whole of preference share/capital must be paid before anything is paid to the equity share/capital. Thus, preference share/capital stands midway between debentures and equity as regards claims on the income and assets of the company. It is also referred to as a senior security. Stated in terms of risk perspective, the preference share is less risky than ordinary shares but more risky than debentures.
Cumulative Dividends : The preference share is cumulative, in the sense that all unpaid dividends are carried forward and payable before any ordinary dividend is paid.
Redeemability : The preference share has a limited life/specified/fixed maturity (typically 7 years) after which it must be retired. However, there are no serious penalties for breach of redemption stipulation.
Fixed Dividend : Preference share dividends are fixed and expressed as a percentage of par value. Yet, it is not a legal obligation and failure to pay will not force bankruptcy. Preference shares are also called a fixed income security.
Convertibility : Preference shares may sometimes be convertible partly/fully into equity shares/debentures at a certain ratio during a specified period. A variant in India is the cumulative convertible preference shares that combines the cumulative and convertibility features. It has, however, been a virtual non-starter so far.
Voting Rights : A preference share ordinarily does not carry voting rights. It is, however, entitled to vote on every resolution if (i) the preference dividend is in arrear for two years with respect to cumulative preference sharesor (ii) the preference dividend has not been paid for a period of two or more consecutive preceding years or for an aggregate period of three or more years in the preceding six years ending with the expiry of the immediately preceding financial year.
Participation Features : The preference share may be participating or entitling participation in surplus profits, if any, that is, profit after payment of preference dividend and equity dividend, at a certain specified rate. Similarly, it may be entitled to participate in the residual assets after the payment of their normal claim, according to a specified formula, in the event of liquidation of the company.
