Question

Explain the differences between equity and preference shares and explain different types of preference shares.

Hint:

Preference shares offer a balance between equity and debt, providing stable returns with a limited level of risk.

Answer 1

(1) Differences Between Equity and Preference Shares:
Equity shares and preference shares are both types of shares issued by a company, but they have different rights and characteristics. Below are the key differences:

Ownership and Control: Equity shareholders are the owners of the company and have voting rights in the company's annual general meetings. Preference shareholders, on the other hand, are not owners and typically do not have voting rights unless specified otherwise.
Dividend Payment: Equity shareholders receive dividends based on the company's profitability, which can vary each year. Preference shareholders, however, receive a fixed dividend, regardless of the company’s profits.
Priority in Payment: Preference shareholders have priority over equity shareholders in receiving dividends and in case of liquidation. Equity shareholders receive their share of profits only after the preference shareholders' dividends are paid.
Risk: Equity shareholders bear higher risk because their dividends depend on the company's performance. If the company performs poorly, they may not receive any dividends. Preference shareholders have less risk since they are entitled to a fixed dividend.
Capital Appreciation: Equity shares have the potential for capital appreciation, as the value of shares may increase based on the company's success. Preference shares generally have limited capital appreciation since their value is tied to the fixed dividend rate.

Conclusion: Equity shares offer more control and higher returns but come with higher risk, while preference shares provide a stable income with priority rights, but with limited control and capital appreciation.
(2) Types of Preference Shares:
There are several types of preference shares, each offering different rights and benefits. Here are the main types:

Cumulative Preference Shares: In the case of cumulative preference shares, if the company is unable to pay dividends in any given year, the unpaid dividends accumulate and must be paid in future years before equity dividends are distributed.
Non-Cumulative Preference Shares: Non-cumulative preference shares do not allow for the accumulation of unpaid dividends. If the company fails to pay dividends in any year, the shareholder cannot claim those dividends in the future.
Convertible Preference Shares: These preference shares can be converted into equity shares of the company at a specified price after a certain period.
Redeemable Preference Shares: These shares are repaid by the company at a fixed date or after a specified period, typically at a predetermined price.
Participating Preference Shares: These shares allow the shareholder to receive additional dividends if the company’s profits exceed a certain limit, in addition to the fixed dividend.
Non-Participating Preference Shares: Holders of these shares are entitled only to a fixed dividend and do not participate in the company’s additional profit-sharing beyond that.

Conclusion: Preference shares offer various benefits depending on the type, allowing companies to meet the preferences of different investors. Cumulative and convertible preference shares, for example, provide more flexibility and advantages to shareholders.