Preference shares: Sec. 85(1) of the Companies Act defines preference shares as those shares which carry preferential rights as the payment of dividend at a fixed rate and as to repayment of capital in case of winding up of the company. Thus, both the preferential rights viz.
(a) Preference in payment of dividend and
(b) Preference in repayment of capital in case of winding up of the company, must attach to preference shares.
The rate of dividend on these shares is fixed and the dividend on these shares must be paid before any dividend is paid to ordinary shares. Directors, however, may decide not to pay any dividend to any class of shareholders even if there are sufficient profits. But, if any how, they decide to pay the dividend, preference shareholders will get the priority to pay the ordinary shareholders.
Features of Preference Shares
Following are the basic features of preference share:
a) Fixed rate of dividend
b) Preferential payment of dividend
c) Preferential right in redemption of capital in case of winding up of a company.
d) Absence of voting rights
Advantages of Preference Shares
1. Helpful in raising long term capital for a company.
2. There is no need to mortgage property on these shares.
3. Redeemable preference shares have the added advantages of repayment of capital whenever there is surplus in the company.
4. Rate of return is guaranteed.
Disadvantages of Preference Shares
1. Permanent burden on the company to pay a fixed rate of dividend before paying anything on the other shares.
2. Not advantageous to investors from the point of view of control and management as preferences shares do not carry voting rights.
3. Compared to other fixed interest bearing securities such as debentures, usually the cost of raising the preference share capital is higher.