Corporations that issue callable preferred stock have the right, but not the obligation, to redeem shares on or after the call date. The right to call the shares doesn't expire. The stock issuer must specify the call details in the security’s prospectus. Corporations may also issue preferred stock with a maturity date. In effect, this is the last call date, the date on which the corporation will forcibly redeem all remaining shares.
Companies issue preferred stock to raise money. The stock pays high fixed dividends that resemble the interest on long-term bonds. Both bonds and preferred stocks are sensitive to changes in interest rates. Preferred shares do not participate in the growth of the company -- the dividend remains the same even if earnings increase. Corporations must pay dividends on all preferred stock before paying common stock dividends. If the corporation liquidates, preferred stockholders get paid before common stockholders but after bondholders.
The prospectus for a callable preferred stock discloses the first date on which the corporation can call the stock. Normally, there is a waiting period, often five years, between the stock issue date and the first call date. Corporations set in advance the price they will pay for called shares. The call price might be the nominal, or par, value of the shares or perhaps a little higher. Once a corporation calls a share, it immediately cancels the share and pays the ex-owner cash.
Corporations are not obligated to call redeemable shares. For instance, if interest rates rise, a corporation might prefer to leave the stock in circulation rather than call it and issue new preferred stock with a higher dividend. Corporations can specify multiple call dates and prices -- a call schedule -- if they wish to redeem shares in installments. A call schedule specifies the number of shares the corporation plans to redeem at each call date.
A corporation can pay for shares scheduled for call with a sinking fund -- a pot of money dedicated to a specific use. For example, XYZ Corp issues 1 million callable preferred shares that mature in 20 years. It creates a call schedule to retire 50,000 shares per year for 20 years at par value of $100 a share. At the same time, XYZ creates a sinking fund containing enough cash and negotiable securities to pay for the annual redemptions. XYZ might not put aside the entire cost, $100 million, all at once -- it need only seed the fund with enough resources to grow to its required.size. XYZ selects by lottery the 50,000 shares to retire annually. The call schedule may offer a lower call price with each call date.
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