The following points highlight the top two classes of shares issued by a joint stock company. The types are: 1. Preference Shares 2. Equity Shares.
Preference shares are those which carry;
(i) A preferential right as to the payment of dividend during the lifetime of the company, and
(ii) A preferential right as to the return of capital when the company is wound up.
These shares carry a right of dividend at a fixed rate before any dividend can be paid on equity shares. The fixed rate of dividend payable is declared at the time of the issue of such shares. Whenever a reference is made to any preference shares issued, the fixed rate of dividend payable is also mentioned.
For example, 12% preference shares mean that dividend at the rate of 12% per annum is payable on these preference shares. Of course, dividend is payable only if there are profits earned by the company and the Board of Directors decides to distribute them wholly or partly by way of dividends.
Kinds of Preference Shares:
A preference share is:
(i) Either cumulative or non-cumulative,
(ii) Redeemable or irredeemable,
(iii) Participating or non-participating, and
(iv) Convertible or non- convertible.
(i) Cumulative vs. Non-cumulative:
The holders of cumulative preference shares are entitled to recover the arrears of preference dividend before any dividend is paid on equity shares.
For example, if dividend has not been paid for the accounting years 2007-2008 and 2008- 2009 on 10% cumulative preference shares and the company wants to distribute dividend on equity shares for the year 2009-2010, then dividend on preference shares for three years viz., 2007-2008,2008-2009 and 2009-2010? 10% per annum i.e., 30% dividend in all will have to be first paid on preference shares before any dividend can be paid on equity shares for 2009-2010.
On the other hand, in case of non-cumulative preference shares, arrears of dividend do not accumulate and hence if dividend is to be paid to equity shareholders in any year, dividend at the fixed rate for only one year will have to be paid to preference shareholders before equity dividend is paid, even if preference shareholders have not received any dividend for a number of earlier years.
In the abovementioned illustration, if the preference shares are non-cumulative, the company will have to pay 10% preference dividend only for 2009-2010 before paying equity dividend; the preference shareholders will lose dividend for 2007-2008 and 2008-2009. Unless specifically mentioned otherwise, preference shares should be considered to be cumulative. In practice, they are always cumulative.
(ii) Redeemable vs. Irredeemable:
Redeemable preference shares are those preference shares whose amount can be returned by the company to their holders within the lifetime of the company subject to the terms of the issue and the fulfillment of certain legal conditions laid down in Sec. 80 of the Companies Act.
The amount of irredeemable preference shares can be returned only when the company is wound up. After the commencement of the Companies (Amendment) Act, 1996, no company limited by shares shall issue any preference share which is irredeemable or is redeemable after the expiry of a period of 20 years from the date of issue.
(iii) Participating vs. Non-participating:
Participating preference shares are entitled not only to a fixed rate of dividend but also to a share in the surplus profits which remain after dividend has been paid at a certain rate to equity shareholders; the surplus profits are distributed in a certain agreed ratio between the participating preference shareholders and equity shareholders.
Preference shareholders may also be given the right to participate in the surplus remaining after the equity share capital has been repaid in case of winding up of the company. Non- participating preference shares are entitled to only the fixed rate of dividend.
(iv) Convertible vs. Non-convertible:
The holders of convertible preference shares enjoy the right to get the preference shares converted into equity shares according to the terms of issue. The holders of non-convertible preference shares do not enjoy this right.
Shares which are not preference shares are equity shares. The balance of profits remaining after appropriating preference dividend can be distributed among the equity shareholders as dividend. In case of winding up of the company, the payment is first made to creditors of the company. Then, the preference share capital is returned. Whatever remains belongs to equity shareholders.
Shares with Differential Rights:
According to section 2 (46 A) as inserted by the Companies (Amendment) Act, 2000 a company can issue in accordance with the provisions of section 86, shares with differential rights as to dividend, voting or otherwise in accordance with such rules and subject to such conditions as may be prescribed.