Q:

What are the disadvantages of preference shares?

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Quick Answer

Despite their benefits, preference shares are limited because of their callable status. The payouts associated with preference shares are based on the discretion of the underlying company. Companies therefore can repurchase preference shares from their holders when interest rates decrease. In addition to their callable status, preference shares are not as transparent as other investment types. Preference shares do not have specific maturity dates or ratings.

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Full Answer

Preference shares are hybrids of sorts; they possess features of both stocks and fixed-income assets such as bonds. Similar to common stocks, preference shares represent ownership in a company, and similar to bonds, preference shares provide regular payouts based on their interest rate.

Preference shares carry less risk than common shares, but more risk than bonds. Interest payments from preferred dividends are not guaranteed to exceed bond rates and preferred shareholders are still exposed to default risk. If the underlying company goes bankrupt, bond holders are placed before preferred shareholders with regards to asset distribution. If a company falters, money is repaid to bond holders first, adding default risk to preference shares. Another disadvantage of preference shares is that preferred shareholders are typically excluded from voting on crucial matters such as board of director elections.

Due to their fixed-income and common share characteristics, preference shares have limited appreciation potential and default exposure. That said, there are a number of strong companies in healthy industries that issue preference shares with dividend payments above investment-grade bonds.

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