Companies sometimes provide that their preferred stock shall be non-cumulative for several years, after which it shall become cumulative. This provision relieves the company of the neces sity of paying full dividends on the preferred stock during the early years when earnings are expected to be small or of having the dividend accumulate as a charge against future years, and yet assures the stock almost as good selling power as if it were fully cumulative from the first.
Redeemable Stock.—Preferred stock, or certain classes of preferred stock, are occasionally made redeemable. This means that the company has the option under the conditions and on terms specified in the certificate of incorporation, of redeeming or buying back the stock from the stockholders. This redemption right rests, of course, entirely with the company, and stock holders can neither compel nor refuse redemption of their stock. Some advance notice of intended redemption is usually pro vided for, and a redemption price is generally set at a premium so as to compensate the holder for the loss of his investment and give him an opportunity to seek a re-investment of his money without suffering loss of income in the interim. Redemption at a premium is not universal, however, many companies having the redemption price set at par. If the redeemable stock has the voting power, its redemption has considerable effect upon the control of the company because of the elimination of all the votes repre sented by it.
Redeemability also may have a material effect upon the market price of a stock, the tendency being to keep the market price lower than it otherwise might be. If the stock is redeemable at no and has an investment value of 140, a buyer would in all probability refuse to pay this much for it, fearing that the cor poration might exercise its redemption privilege and deprive him of his stock at iio, thus bringing about a considerable loss. If, on the other hand, the investment value is below the redemption price, the redemption feature would ordinarily have no effect on the market unless to make the stock slightly less attractive be cause of the fact that there is an upper limit to the possible price rise.
Convertible Stock.—One or more classes of stock may be made convertible, that is, exchangeable at the option of the holder, into some other specified security. Conversion, unlike re demption, is always at the option of the holder. The certificate of incorporation may make certain stipulations or set a certain time limit for the conversion, but within these restrictions the stockholder can demand the conversion at his pleasure. The most
usual conversion permitted is from preferred to common stock. Convertible stock of this type is quite popular because it enables the holder to receive preference as to dividends when the earn ings are small and there is little left for the common dividends, and yet permits him to trade in his stock for common in case the earnings become large and the common is receiving large returns.
The matter of control also frequently enters, as non-voting preferred stock is often convertible into voting common stock. This feature will sometimes induce stockholders to convert, even at a financial loss. Occasionally, stock is issued which is converti ble into bonds. This is rare, however, and is hedged about with various protective stipulations. In the first place, such con version should be only at the option of the company, for if this were not the case, holders of such stock in a weak or insolvent company could convert their stock into bonds and thus share in the proceeds of dissolution ahead of many creditors and on an equal footing with other bondholders of the company who ac quired them through bona fide purchase, which is manifestly unfair. The money which stockholders pay into the company for their ownership is a part of the owned capital of the com pany, and it is upon the strength of this owned capital and the security afforded by it that the company is enabled to obtain its borrowed capital through the sale of bonds. If, therefore, a large number of stockholders are permitted to convert their stock into bonds, thus becoming creditors of the company instead of part owners, it naturally means increase of bonded debt with no in crease whatever of assets, and lessens the value of all other bonds.
Protected Preferred Stock.—Recently some companies have been making some of their preferred stock especially attractive as an investment by "protecting the dividend." This means simply that after the preferred dividend is paid, a certain amount is placed each year in a reserve or sinking fund, before the dividend is paid to the common stock. This sinking fund is built up to some required size and is to be used to pay the preferred divi dends in case of poor years when the current surplus would not be sufficient. When this fund reaches the stipulated size, it is not built up further, but the dividends can then go direct to the com mon stock without the fund payment coming in ahead. If the fund is depleted, however, by being drawn on to meet a preferred dividend in a poor year, it must be built up to full requirements again as before.