What is a Preference Share? Explain the Features of Preference Shares | 12th HSC S.P. Chapter 2
The question "What is a Preference Share? Explain the features of Preference Shares" is a major long answer question from Maharashtra State Board (MSBSHSE) 12th Standard HSC Secretarial Practice (S.P.) Chapter 2: Sources of Corporate Finance. In the HSC Board Examination, this question frequently appears in Question 8 (Answer the Following) for 8 Marks (or in Question 5 for 4 Marks). Below is the complete, step-by-step model answer strictly aligned with the latest Balbharati Textbook and official board marking scheme.
Board Examiner Marking Scheme (8 Marks):
1. Meaning & Legal Definition (Section 43): 2 Marks
2. Explanation of Features (Any 6 to 8 valid points with sub-headings): 6 Marks
Presentation Tip: We have provided all 10 official Balbharati textbook points below. Studying at least 8 points guarantees a full 8 out of 8 score!
1. Meaning and Definition of Preference Shares
Meaning of Preference Shares
As the name indicates, Preference Shares are those shares which enjoy certain preferential rights (priorities) over equity shares. They carry a special priority regarding the payment of annual dividend and the return of capital at the time of winding up of the company. Preference shareholders are co-owners of the company, but unlike equity shareholders, they do not enjoy normal voting rights or control over the management.
Legal Definition (Section 43(b) of the Companies Act, 2013)
According to Section 43(b) of the Companies Act, 2013, a Preference Share is one which fulfills the following two essential conditions:
- Preference for Dividend: It carries a preferential right to receive dividend (either as a fixed amount or an amount calculated at a fixed rate) during the lifetime of the company, before any dividend is paid to equity shareholders.
- Preference for Repayment of Capital: It carries a preferential right to the repayment of paid-up capital in the event of winding up (liquidation) of the company, before any capital is returned to equity shareholders.
2. Quick Revision Chart: 10 Features of Preference Shares
Drawing this quick summary list of the 10 features before explaining them helps the board examiner award full marks immediately:
| Sr. No. | Feature Heading (Balbharati Textbook) | Key Keyword for Exam |
|---|---|---|
| 1. | Preference for Dividend | First charge on distributable net profit |
| 2. | Preference for Repayment of Capital | Paid before equity shareholders during winding up |
| 3. | Fixed Return | Pre-determined, fixed rate of dividend out of profits |
| 4. | Nature of Capital | Safe Capital; redeemable within maximum 20 years |
| 5. | Market Value | Remains steady/stable; no wide fluctuations |
| 6. | Voting Rights | No normal voting rights; vote only on matters affecting them |
| 7. | Risk | Less risky; steady return and priority in repayment |
| 8. | Face Value | Relatively higher than equity shares — usually Rs. 100/- |
| 9. | Rights or Bonus Issue | Not entitled to Bonus Shares or Rights Issue |
| 10. | Nature of Investor | Attracts cautious, conservative, and safety-conscious investors |
3. Detailed Explanation: Features of Preference Shares
1. Preference for Dividend
Preference shares hold the first charge on the distributable net profit of the company. Whenever the company earns distributable profit and decides to declare a dividend, the dividend is payable to preference shareholders first, before any dividend is paid to equity shareholders.
2. Preference for Repayment of Capital
Preference shareholders also have a preferential right over equity shareholders in respect of return of capital when the company is wound up (liquidated). After paying all external creditors and debenture holders, the company repays preference share capital in full before returning any money to equity shareholders. It saves preference shareholders from heavy capital losses.
3. Fixed Return
These shares carry dividend at a fixed, pre-determined rate (e.g., 9% Preference Shares). The rate of dividend is decided at the time of issue. This fixed dividend is payable only out of the net profits of the company. During a financial crisis or loss, the Board of Directors may decide not to pay dividend cleanly unless they are cumulative preference shares.
4. Nature of Capital
Preference shares do not provide permanent capital to the company. They are redeemed (repaid) after a certain fixed period of time. As per Section 55 of the Companies Act, 2013, a company cannot issue irredeemable preference shares, and preference shares must be redeemed within a maximum period of 20 years from the date of issue. Preference capital is generally raised at a later stage when the company is well-established, and it is called "Safe Capital" because the rate of dividend and market value remain stable.
5. Market Value
The market value of preference shares does not change (fluctuate) widely because the rate of dividend payable to them is fixed. Therefore, there is very little scope for capital appreciation as compared to equity shares, and they do not attract stock market speculators.
6. Voting Rights
The preference shareholders do not enjoy normal voting rights at general meetings. They do not enjoy the right of control over the affairs and management of the company. They can vote only on those resolutions of the company that directly affect their rights (such as winding up of the company, repayment or reduction of preference share capital), or if their dividend remains unpaid for two or more consecutive years.
7. Risk
The investors who are cautious generally purchase preference shares. Safety of money and a steady fixed return are the primary advantages attached to these shares. Moreover, they are a boon for shareholders during a depression period when interest rates are continuously falling, as their fixed dividend rate remains protected.
8. Face Value
The face value (nominal value) of preference shares is relatively higher than that of equity shares. They are normally issued having a face value of Rs. 100/- per share.
9. Rights or Bonus Issue
Preference shareholders are not entitled to get Bonus Shares (free shares) or Rights Issue of shares. These privileges are reserved exclusively for the existing equity shareholders of the company.
10. Nature of Investor
Preference shares attract moderate and cautious types of investors. Investors who are conservative, cautious about the safety of their principal investment, and interested in fixed, regular returns on investment prefer to buy preference shares.
Quick Memory Trick to Remember All 10 Points in the Exam
Memory Shortcut (Mnemonic — "PP-FN-MV-RF-RN"):
Notice that the points are the exact opposite of Equity Shares! Group them into 3 easy sets:
1. The 3 Priorities & Return: Preference for Dividend, Preference for Capital Repayment & Fixed Return
2. Capital, Market & Control: Nature of Capital (Safe/Redeemable), Market Value (Stable) & Voting Rights (No Normal Voting)
3. Investor & Value: Risk (Low Risk), Face Value (Rs. 100), No Rights/Bonus Issue & Nature of Investor (Cautious)
Key Concept Summary for Objective Questions (Q.1)
- Safe Capital: Preference Share Capital is considered "Safe Capital" because it carries a fixed rate of dividend and priority in repayment of capital.
- Face Value of Preference Shares: The face value of preference shares is relatively high—normally Rs. 100/-.
- Co-owners but Not Controllers: Preference shareholders are co-owners of the company, but they are not controllers because they do not enjoy normal voting rights.