Definition
Participating Preference Shares are a type of preference share that entitles holders to a predetermined fixed dividend and an additional share in a company’s profits. This additional share is typically granted after ordinary shares have received a certain percentage. These shares provide an advantage over regular preference shares as they can yield higher dividends when the company performs well.
Examples
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Company A Issues Participating Preference Shares: Suppose Company A issues participating preference shares. These shares guarantee a 5% annual dividend. In a profitable year, if ordinary shareholders receive a dividend exceeding a specified threshold, such as 10%, participating preference shareholders will also receive additional dividends proportionate to the excess profits.
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Scenario of Additional Profit Sharing: In a financial year, Company B made extraordinary profits. The ordinary shareholders received a 12% return. As per the terms, after achieving a 10% threshold for ordinary shares, the participating preference shareholders are entitled to share 2% of the excess profits. Thus, in addition to the fixed 5% dividend, these shareholders will receive an extra 2%.
Frequently Asked Questions (FAQs)
Q1: How are participating preference shares different from regular preference shares?
A1: Participating preference shares not only offer a fixed dividend but also allow holders to participate in additional profits beyond certain thresholds, which regular preference shares do not.
Q2: Are participating preference shares a good investment?
A2: They can be, especially in profitable companies, as they offer both fixed and variable returns. However, they also come with certain risks associated with the company’s profitability.
Q3: Do participating preference shareholders have voting rights?
A3: Typically, preference shareholders, including those with participating preference shares, do not have voting rights in the company’s general meetings, although specifics can vary based on the company’s articles of association.
Q4: When do participating preference shares receive additional dividends?
A4: They receive additional dividends after ordinary shareholders receive dividends surpassing a predefined threshold.
Q5: Are dividends from participating preference shares guaranteed?
A5: The fixed portion of the dividend is generally guaranteed, subject to the company’s ability to pay. The additional share in profits is contingent on the company’s performance.
Q6: Can a company issue both participating and non-participating preference shares?
A6: Yes, a company can issue both types depending on its financial strategies and the terms set forth in the share issuing agreement.
Preference Share
A type of equity security that typically pays fixed dividends and has preference over ordinary shares in the distribution of dividends and assets.
Ordinary Share
A share in a company that provides the shareholder with voting rights and a variable dividend, dependent on the company’s profitability.
Dividend
A portion of a company’s earnings distributed to its shareholders. Dividends can be issued in cash, additional shares, or other forms.
Online References
- Investopedia - Preference Shares
- Investopedia - Participating Preferred Stock
Suggested Books for Further Studies
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“Financial Markets and Corporate Strategy” by David Hillier, Mark Grinblatt, and Sheridan Titman
- Detailed discussion on different types of shares including preference shares and their strategic use.
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“Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, Franklin Allen
- Comprehensive coverage on corporate finance principles such as valuations, bond pricing, and share structures.
Accounting Basics: “Participating Preference Shares” Fundamentals Quiz
### What are participating preference shares entitled to besides a fixed dividend?
- [ ] Only voting rights.
- [ ] Reduction in share price.
- [x] Additional share in company profits after certain conditions.
- [ ] Higher fixed interest rates.
> **Explanation:** Participating preference shares offer both a fixed dividend and an additional share in the company’s profits once certain conditions are met.
### Do participating preference shares usually grant voting rights to shareholders?
- [ ] Yes, they do.
- [x] No, they generally do not.
- [ ] They grant double voting rights.
- [ ] Voting rights are conditional on company performance.
> **Explanation:** Typically, participating preference shares do not provide voting rights, although specifics can vary based on the company's rules.
### How does the dividends distribution work for participating preference shareholders?
- [ ] Dividends are only allocated when company profits are low.
- [x] Fixed dividends are first allocated, and additional profits are shared after a threshold for ordinary shares.
- [ ] Dividends are allocated based on market performance.
- [ ] Dividends are distributed equally among all types of shares.
> **Explanation:** Participating preference shareholders receive a fixed dividend first; any additional profit sharing happens after ordinary shareholders surpass a certain dividend threshold.
### Under what circumstances might participating preference shareholders receive extra dividends?
- [ ] Only during a loss-making year.
- [x] When ordinary shareholders receive dividends exceeding a specified level.
- [ ] Whenever dividends are paid out regardless of amount.
- [ ] When the company becomes a public corporation.
> **Explanation:** Participating preference shareholders receive extra dividends when the profits allow ordinary shareholders to get more than a predefined dividend amount.
### Which of the following can be said about regular (non-participating) preference shares?
- [x] They only provide a fixed dividend.
- [ ] They offer variable dividends.
- [ ] Additional profit sharing is guaranteed.
- [ ] Shareholders always have voting rights.
> **Explanation:** Regular preference shares only offer fixed dividends and do not participate in additional profit sharing.
### What is a key advantage of holding participating preference shares?
- [ ] Constant payment of capital back.
- [ ] Guaranteed voting rights.
- [x] Participation in additional profits beyond fixed dividends.
- [ ] Lower share price variability.
> **Explanation:** The key advantage of holding participating preference shares is the potential to receive additional dividends based on company performance.
### In which financial scenario are participating preference shares advantageous?
- [x] In highly profitable years.
- [ ] During periods of company loss.
- [ ] Only during initial public offerings.
- [ ] Always, regardless of company state.
> **Explanation:** Participating preference shares are particularly advantageous during highly profitable years as they allow for both fixed and additional dividend payments.
### How does the dividend structure of participating preference shares benefit investors?
- [ ] By providing constant portfolio borrowing options.
- [ ] Through reinforced market exposure risk.
- [x] With both secure fixed dividends and potential for higher returns through extra profit sharing.
- [ ] By strictly limiting returns and participation in profits.
> **Explanation:** Investors get the benefit of secure fixed dividends and potential higher returns if the company's profits exceed certain thresholds.
### What primarily distinguishes participating preference shares from ordinary shares?
- [ ] Participation in loss sharing.
- [x] Fixed dividends plus additional profit-sharing ability.
- [ ] Higher voting rights in company decisions.
- [ ] Increased share buyback guarantees.
> **Explanation:** Participating preference shares are primarily distinguished by their fixed dividends plus the additional profit-sharing potential which ordinary shares do not have.
### Can a company issue both participating and non-participating preference shares simultaneously?
- [ ] No, only one can be issued at a time.
- [x] Yes, based on strategic financial requirements.
- [ ] Only if shareholders agree unanimously.
- [ ] They must alternate each year.
> **Explanation:** A company can issue both participating and non-participating preference shares according to its financial strategy and share issuing terms.
Thank you for exploring the concept of “Participating Preference Shares” and taking on the quiz. Continue advancing your accounting acumen!
