Discuss the reasons that investors buy preferred stock and the dividend rights of preferred stockholders

Answer 1

Owners of preferred stock have a claim on the assets of a firm that is senior to the claim of common shareholders. Preferred shares also carry special rights. The senior status and special rights may induce certain investors to purchase preferred shares of a firm, even though they would be unwilling to purchase common shares of the same firm. The senior status and special rights reduce the risks of preferred shareholders relative to common shareholders. Preferred shareholders should therefore expect a lower return than common shareholders. Preferred shares vary with respect to the rights and obligations of the issuing firm and of the investor in the preferred shares.

Dividend Rights

Preferred shares usually entitle their holders to dividends at a certain rate, which the firm must pay before it can pay dividends to common shareholders. Firms may sometimes postpone or omit preferred dividends. Most preferred shares, however, have cumulative dividend rights, which means that a firm must pay all current and previously postponed preferred dividends before it can pay any dividends on common shares.