Preferred Stock And Common Stock

In recent years there has been a considerable increase in the popularity of convertible preferred stocks, which bear with them a right to convert into the common stock of the issuing corporation at a stated rate; this rate may be on a share-for-share basis or may be a fraction, such as three quarters of a share of common for each share of preferred. Should the common be of increasing value throughout the years, it is evident that this conversion right may become very valuable. If the reverse is true, then the privilege may become entirely worthless.

In some cases conversion rights may be in effect for a considerable length of time; in others there is a definite period during which they may be exercised and usually at a decreasing rate of conversion with the passage of time. At any rate, conversion rights must be protected against dilution through mergers, stock dividends, splits, etc., and such protection is usually provided in the articles.

Some corporations achieve the same result as conversion by attaching common-stock purchase warrants to the preferred shares; these may be detached and returned to the corporation with the specified amount of cash required. As a rule such warrants are limited in time, but in a few cases they are specified as perpetual.

In many cases there is written into the articles of incorporation a regulation which obliges the purchase and retirement of a certain number of preferred shares annually. This is known as a "sinking fund" provision. The corporation sets aside from its earnings each year a certain amount, say $50,000, and it is required to redeem preferred shares in that amount by exercising the right of call at a specified price. As a rule, the selection of such shares is made by lot. To the investor who may be anxious to preserve his investment in its entirety, this calling of shares for redemption may be annoying; but there is some compensation in the fact that the retirement of some shares reduces the number of shares outstanding and therefore tends to increase the assets behind those which remain; in addition, there will be some tendency to stabilize the price of those remaining, because the shares which are called for redemption are permanently removed from the market.