Is Preferred Stock Debt or Equity?

Is Preferred Stock Debt or Equity?
Is Preferred Stock Debt or Equity?

Cash Income

Like any other debt instrument, preferred stock guarantees regular payments of a preferred dividend. Many investors invest in preferred stock when looking for a steady cash income. While interest payments on regular debt cannot be missed without risking going into default, preferred dividend on the hybrid debt of preferred stock can be suspended from time to time. However, any omitted payments must be accumulated and made up for later.

Equity Capital

Even though preferred stock pays out regular cash income, it does not promise the return of the investment principal like a corporate bond, as the company intends to hold the investment as equity capital. In certain cases, regular debt holdings may be converted to preferred stock as equity contributions when a company seeks relief from its obligations of paying back debt principals at the upcoming due dates. Preferred stock is always listed in the equity section of a company's balance sheet.

Creditor-Like Rights and Liabilities

Like creditors that provide debt financing without having control over company operations, preferred shareholders are also granted no voting rights over management issues. Preferred stock as non-voting equity does not bear the ultimate liability of a company's failure. In a liquidation and bankruptcy proceedings, both creditors and preferred shareholders get preferential treatment over holders of common stock.

Stock-Like Exchange Trading

Like common stock, preferred stock as part of the owner's equity is also exchange listed and traded. Its trading can be directly affected by corporate earnings, particularly for preferred stock that features earnings participation. In addition to receiving fixed income, this kind of preferred stock may further share company profits with common stock, a feature that pure debt securities do not have.

Other Features

Preferred stock can resemble debt and equity on many different aspects, but it may not bear the complete resemblance. Take the example of making regular fixed payments by both preferred stock and a debt security. For debt, interest expense is tax deductible and the company can recover part of the interest payment by a percentage point equal to its corporate tax rate. For preferred stock, dividend expense is paid using after-tax profit. So tax savings on interest expense makes debt financing less expensive than preferred stock financing.