Bonds are just loans (debt) and have a fix maturity date when the company has to pay back the bonds.
Common stock and preferred stock are equity and represent partial ownership in a company. Common stock holders receive their share of the profits and losses from the company in proportion to the number of shares they own.
Preferred stock is a bit different from common stock. Preferred stock is a hybrid of common stock and bonds. Almost all preferred stock have a fixed dividend rate (like the interest from bonds). Dividends must be paid to preferred stock before they can be paid to common stock. Like common stocks but unlike bonds. preferred stocks do not have a maturity date, so the company never has to pay back the money it got from investors.
Unlike common stock and like bonds, preferred stock usually have no voting rights.
In accounting rules, the interest a company pays counts as a cost. Companies pay interest before paying taxes. In contrast, the dividends paid to preferred stock holders are after tax, which isn't very tax efficient and do not count as cost or expense. Issuing preferred stock instead of bonds results in lower costs (in accounting sense), better profit margins as a result of lower costs, and thus, better earnings.
In bankruptcy court, bond holders and creditors rank among the highest, with common stock holders having the lowest rank. Preferred stock rank just above common stock. This means when a bankrupt company is liquidated, proceeds (if any) must first be paid to the people whom the company owes money to (includes employees, IRS, and bond holders) before the money goes to the stock holders (owners). Preferred stock holders may receive some money but common stock holders usually receive none.
In the U.S. under a tax cut act, most people pay less taxes on dividends than interest income. Most pay 15% on dividend income while interest income is taxed as regular income tax, as high as 35%. Corporations receive special tax benefits on preferred stock dividends.
some of this comes from Motley Fool
· 1 decade ago