In addition to common stock, firms often issue preferred stock, which has a priority claim over common stock with respect to dividends. In addition, if the firm should liquidate its assets and cease to exist, preferred shareholders’ claims would be satisfied before any assets were distributed to the common stockholders.
The description of preferred stock in corporate financial reports discloses the special features of the stock issue. To illustrate, Exhibit 9.1 shows the description of Sequel Corporation’s preferred stock contained in its 2001 annual report. Sequel’s preferred shares have an annual dividend of $5 per share. Analysts would also note that Sequel’s preferred shares are cumulative and convertible. Cumulativeindicates that if the firm does not declare a dividend in any year, the amount accumulates and must be paid before any dividends are paid to common stockholders. If Sequel did not pay dividends for three years, for example, then a cumulative dividend of $15 per share ($5 * 3 years) must be paid to preferred shareholders before dividends are paid to common shareholders.
Convertible preferred shares can be exchanged for common shares at the preferred shareholders’option. To illustrate, each share of Sequel’s preferred stock is converted into 1.322 shares of common stock. Presently, 797,000 shares of preferred stock have been issued. If the entire issue were to be converted to common stock, then Sequel would issue 1,053,634 common shares (797,000 preferred shares * 1.322 exchange ratio) and would retire the preferred stock. In this case, the preferred stock component of shareholders’ equity is eliminated and transferred to common stock. Note that the conversion of preferred stock does not change total shareholders’equity. Assets and liabilities are also unaffected. The number of common shares outstanding increases, however, and the preferred stock’s dividend requirement is eliminated.
2001 Annual Report
Footnote Disclosures of Preferred Stock (Partial)
The Company’s capital stock consists of Class A and Class B common stock, and $5.00 cumulative convertible preferred stock.
Each share of $5.00 cumulative convertible preferred stock is convertible into 1.322 shares of Class A common stock. On December 31, 2001, 4,543,636 shares of Sequel Class A common stock were reserved for conversion of preferred and Class B common stock and stock options. On December 31, 2001, 5,724 Class B common shares were reserved for stock options. The preferred stock is redeemable, at the option of the Company, at $100 per share.