Rights of Preferred Stockholders

Now that you know the types of preferred stock, let's examine what rights preferred stockholders actually have. Understanding these rights (especially where preferred falls in the liquidation hierarchy) is important for exam success.

Preference Upon Corporate Dissolution (Liquidation)

In bankruptcy or liquidation, claims are paid in a strict order known as the absolute priority rule. Preferred stockholders sit above common but below all forms of debt.

Priority of Claims

• Preferred stockholders receive their par value (or liquidation value) before common stockholders receive anything
• Preferred is senior to common but junior to all debt
• If there is not enough money to pay all preferred stockholders in full, common stockholders receive nothing

Remember: The liquidation hierarchy follows the same pattern as risk: higher risk = lower priority. Common stockholders take the most risk and are paid last.

Exam Tip: Gotchas

• Preferred stockholders are senior to common but junior to ALL debt holders in liquidation. Even if a company has billions in preferred stock outstanding, every bondholder and creditor gets paid first.

Dividend Payment Preference

• Preferred dividends must be declared and paid before any common dividends
• The board of directors must still declare the dividend; preferred dividends are not automatic or guaranteed
• If the board does not declare a dividend, no one receives one
• For cumulative preferred, undeclared dividends accumulate as arrears (covered in the previous section)

Key point: "Preference" does not mean "guarantee." It means preferred gets paid first IF the board declares a dividend. The board can choose to declare no dividends at all.

Exam Tip: Gotchas

• The board of directors must declare dividends; they are never automatic. Even preferred stockholders receive nothing if the board chooses not to declare. The preference only means preferred gets paid BEFORE common, not that preferred is guaranteed payment.

No Voting Rights (Generally)

• Preferred stockholders typically do not vote
• Some preferred shares grant contingent voting rights if dividends are missed for a specified number of periods (e.g., after 6 consecutive missed quarterly dividends)
• Preferred stockholders do not elect the board of directors under normal circumstances
• This lack of voting power is one of the tradeoffs for receiving the fixed dividend and liquidation preference

Exam Tip: Gotchas

• Preferred stockholders generally cannot vote. Contingent voting rights may activate after missed dividends, but under normal circumstances preferred holders do not elect the board of directors.
• Pre-emptive rights belong to common stockholders, not preferred. If you see a question about who has pre-emptive rights, the answer is common.

Comparison of Rights: Preferred vs. Common