When one class of stock retains the voting power and another, class has preference as to principal or divi dends, the latter is the preferred because voting privi leges are second in importance to security. It is usually considered that the common stockholders, who take the marginal risks of the business, should possess the voting control. It is their only protection.
A stock which is preferred as to principal receives its full par value when the company is liquidated, fare anything is paid upon the principal of common stock. Preference as to dividends indicates that the preferred must receive a stated dividend before any thing may be paid out of profits to common stock holders. Voting control, whether it relates to pre ferred or common, indicates the power to vote at the election of directors, or upon certain specific questions of policy which may be brought before the stock holders for decision.
It should be noted that preference as to principal does not make the stock a liability of the company. Such preference becomes operative only upon liquida tion and is even then secondary to the claims of all creditors. Preferred dividends are not fixed charges of the company, but are payable out of earnings, on vote of the directors, in the same manner as common dividends. There may be several classes of preferred stock, known as first, second, and third preferred, etc., each possessing some stated degree of preference.
7. Purposes of preferred stock.—The purposes of issuing preferred stock may be summarized as fol lows : (a) To enable common stockholders to trade or control upon a thinner equity.
(b) To scale down junior lien bonds and reduce fixed charges in reorganization.
(c) To pay for properties or securities purchased in consolidating.
(d) To secure capital when the sale of bonds or common stock is not practicable or advisable.
Many investors who are perfectly willing to kn.
preferred shares surrounded with adequate safe guards and bearing liberal cumulative dividends will not purchase common stock. Preferred stock appeals to a class midway between bond investors and those who desire the speculative risks and profits of common stock. Preferred stock is inferior to bonds, as to both principal and interest, and therefore it demands a higher return. It usually bears cumulative dividends
of from six to eight per cent, while bonds receive cum ulative interest of from four to six per cent. Bonds possess a strong contingent control in the form of the right to foreclose upon default of either principal or interest. Preferred stock has no such contingent right, but insists instead upon some voting powers or restraints upon the management.
Preferred stock is passing out of favor with rail ways, for the reason that they have sufficient bonding power to absorb a large portion of their earnings and cannot afford to pay the higher interest rate de manded upon preferred stock. Industrial corpora tions, on the contrary, usually do not possess suffi ciently stable assets or earnings to serve as a basis for bonds in any large amount, and therefore they are compelled to rely mainly upon the sale of preferred stock.
8. Equity and voting power of preferred stock.—It is evident that the issue of preferred narrows the equity and increases the profits of common stock holders in the same manner as the issue of bonds, but to a lesser extent. With the common in control, the sale of preferred shares is equivalent to borrowing, as far as the common stockholders are concerned, except that they pay a higher rate of interest upon preferred than upon bonds, and do not subject the company to the foreclosure rights which bondholders would possess.
It is evident that the preferred stockholder bene fits likewise from the sale of bonds which bear a lower rate of interest than the preferred is receiving, because the surplus earnings thereby accruing to the corpora tion increase the margin, of safety for the preferred stock. But borrowing on bonds, which bear a rate as high as, or higher than, the preferred is less advan tageous to existing shares than the sale of new pre ferred stock, unless the bonds are sold at a premium. This is true because such bonds naturally increase the risks of preferred shares, without either increasing the earnings to the company or the margin of safety to existing preferred any more rapidly than would an additional issue of preferred stock.