Question

Discuss the importance of preference shares as sources of long-term finance.

Explain the advantages of preference shares.

Answer 1

1. Appeal to Cautious Investors: Preference shares can be easily sold to investors who prefer reasonable safety of their capital and want a regular and fixed return on it. These shares carry a preferential right of repayment in the event of liquidation of the company.
2. No Obligation for Dividends: A company is not bound to pay dividend on preference shares if its profits in a particular year are insufficient. It can postpone the dividend in case of cumulative preference shares also. No fixed burden is created on its finances.
3. No Interference: Generally, preference shares do not carry voting rights. Therefore, a company can raise capital without dilution of control. Equity shareholders retain exclusive control over the company.
4. Trading on Equity: The rate of dividend on preference shares is fixed. Therefore, with the rise in its earnings, the company can provide the benefits of trading on equity to the equity shareholders.
5. No Charge on Assets: Preference shares do not create any mortgage or charge on the assets of the company. The company can keep its fixed assets free for raising loans in future.
6. Flexibility: A company can issue redeemable preference shares for a fixed period. The capital can be repaid when it is no longer required in business. There is no danger of over-capitalisation and the capital structure remains elastic.
7. Variety: Different types of preference shares can be issued depending on the needs of investors. Participating preference shares or convertible preference shares may be issued to attract bold and enterprising investors.