Introduction to accounting for preferred stock

There are three main forms of financing available to a corporation. In this article, we discuss preferred stock, the middle-of-the-road option that sits between debt and common equity.

1. General characteristics of preferred stock

A corporation has a high degree of flexibility when figuring out how best to finance operations. Taking on debt is usually inexpensive but restrictive and issuing common stock means giving up a lot of corporate control. A third option is to issue preferred stock, a customizable security which toes the line between debt and equity. Like debt, preferred stock carries a stated percentage rate - unlike debt, however, this percentage is a dividend rate, not an interest rate. Below, we’ll discuss why this difference is so important, but we should first cover four basic characteristics of preferred stock.

First, preferred stock has a par value and a stated dividend rate - for example, a corporation might issue $100, 8% preferred stock. That means every share of the stock yields an annual dividend of $8. Second, preferred stockholders are paid before common stockholders when the company is liquidated. Creditors and bondholders, however, are paid before both types of stockholders. The third characteristic is that preferred stock does not carry voting privileges. Finally, like common stock, preferred stock can be bought and sold on secondary markets.

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Introduction to accounting for preferred stock