Voting Rights and Ownership Characteristics

In addition to issuing common or preference shares, companies can also issue different classes of these shares to further tailor the securities to the needs of the company and its investors.

Common Shares

• Voting rights: Different classes of common shares may vary significantly in the amount of voting power they offer shareholders. For example, a class of common stock may make up a small minority of the equity stake but still allow its shareholders to maintain control over a company due to differing voting rights.
• Liquidation proceeds: Common stock, regardless of its class, will have the right to proportionally share in any assets available for distribution to shareholders in the event of liquidation or dissolution.
• Dividends: Common stockholders will share in any dividend declared by the Board of Directors, contingent on the preferential rights of any outstanding preferred stock.
• Preemptive rights: These are a privilege given to common shareholders that allows them to maintain their proportional ownership in a company when new shares are issued. These rights are designed to protect shareholders from dilution of their ownership stake.

Preference Shares

• Cumulative: Preference shares may differ in their rights to accumulated unpaid dividends.
• Participating: Preference shares may differ in their rights to receive a bonus dividend payment if the company’s profits exceed a pre-specified level.
• Callable/putable: Certain preferred shares may be callable by the issuer or putable by the investor.
• Convertible: Some preference shares may be convertible into common shares at a ratio determined at issuance.

Question

What type of preference share is likely to give the investor the most exposure to a company’s upside potential?

1. Convertible.
2. Cumulative.
3. Participating.

Solution

The correct answer is A.

Convertible preference shares allow the investor to convert their preferred shares into a predetermined number of common shares. This provides the investor with potential exposure to the company’s upside, as they can benefit from capital appreciation if the company’s stock price increases.

B is incorrect. Cumulative preference shares primarily protect the investor by ensuring any missed dividend payments are accumulated and must be paid in the future before common shareholders can receive dividends. However, they do not directly offer more upside potential compared to common shares.

C is incorrect. Participating preference shares give the investor the right to receive additional dividends beyond the fixed rate if the company performs well, but this feature generally offers less upside exposure than the potential capital gains from convertible shares.