Differences between Common Stock and Preferred Stock
Contents
Common stock vs. preferred stock[edit]
Publicly traded corporations often issue different classes of equity to raise capital from investors. The two primary types of shares are common stock and preferred stock. While both represent ownership in a company, they differ in their legal protections, payment priority, and influence over corporate governance. According to the Securities and Exchange Commission, common stock is the most frequent form of equity issued, providing shareholders with a claim on profits and the right to vote on corporate policy.[1] Preferred stock functions as a hybrid security, sharing characteristics with both equity and fixed-income bonds.
Comparison table[edit]
| Feature | Common stock | Preferred stock |
|---|---|---|
| Voting rights | Usually one vote per share | Generally no voting rights |
| Dividend priority | Paid after preferred shareholders | Paid before common shareholders |
| Dividend amount | Variable; determined by the board | Fixed or set at a specific rate |
| Liquidation rank | Lowest priority (residual claim) | Priority over common shareholders |
| Price volatility | Higher price fluctuations | Lower price fluctuations; trades like a bond |
| Investment goal | Long-term capital appreciation | Regular income and capital preservation |
| Callability | Rarely callable | Often callable by the issuer |
| Arrears | No right to past unpaid dividends | Cumulative shares allow for back-payment |
Dividend priority and structure[edit]
Preferred shareholders receive dividends before common shareholders. If a company lacks sufficient cash to pay all investors, it must fulfill its obligations to preferred holders before distributing any funds to common holders. Preferred dividends are usually fixed at a specific percentage of the par value.[2]
Many preferred shares are "cumulative," meaning that if a company misses a dividend payment, the unpaid amount accumulates in arrears. The company must pay these overdue dividends to preferred shareholders before any future dividends can be paid to common shareholders. In contrast, common stock dividends are never guaranteed and can be reduced or eliminated at any time by the board of directors without a legal requirement to pay them back later.
Voting rights and corporate governance[edit]
Common stock provides the primary mechanism for shareholder activism and corporate control. Common shareholders elect the board of directors and vote on major corporate actions, such as mergers or changes in the company's charter.
Preferred stock typically excludes these voting rights. However, preferred shareholders may gain limited voting power if the company fails to pay dividends for a specified period. Because preferred shares offer less influence over management, they are often used by institutional investors who prioritize steady cash flow over the strategic direction of the company.[3]
Liquidation and risk[edit]
In the event of bankruptcy or liquidation, the claims of common shareholders are the last to be satisfied. Creditors, bondholders, and preferred shareholders are all paid before common shareholders receive any remaining assets. This position makes common stock the highest-risk component of a company's capital structure. However, because preferred shares have a fixed dividend, they do not participate in the company's growth to the same extent as common shares. If a company's value doubles, the common stock price typically reflects that growth, whereas the preferred stock price remains tied to interest rates and its fixed dividend yield.
