In addition to issuing common or preference shares, companies are also able to issue different classes of these shares to further tailor the securities to the needs of the company and its investors.
- 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: different classes of common shares may differ in priority and amount of proceeds to be received by shareholders in the event of a liquidation.
- Callable/putable: certain common shares may be callable by the issuer or putable by the investor.
- Other ownership rights: classes of common shares may also differ in dividend payments, conversion rights, and rights in the event of a split or subdivision of another class of 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.
- Convertible: some preference shares may be convertible into common shares at a ratio determined at issuance.
What type of preference share is likely to give the investor the most exposure to a company’s upside potential?
The correct answer is C.
There is no limit to the potential upside of convertible preference shares since they are convertible to common shares at a fixed ratio.
Option A is incorrect. Cumulative preference shares may help an investor recover lost income if a company is returning to profitability, but ultimately shareholders capture minimal returns on the upside.
Option B is incorrect. Similarly, participating shares are limited to a fixed bonus dividend on the upside.
Reading 47 LOS 47b:
Describe differences in voting rights and other ownership characteristics among different equity classes