Ordinary shares vs preference shares: two ways to own a company

Buy a share in a company and you become one of its owners. But not every owner holds the same kind of stake. A company can issue more than one class of share.

The two a student meets most often are ordinary shares and preference shares. Both make the holder a member of the company, not a lender to it.

The rights attached to each are quite different. One offers a steady, predictable return and an early place in the queue. The other offers an uncertain reward but the fullest share in the company’s success.

Two classes of owner

Ordinary shares and preference shares are both share capital, and both sit within equity, the part of the business that belongs to its owners.

Neither is a loan. The company does not have to hand the money back on a set date, as it must with a debenture.

What separates the two shares is the bundle of rights each carries. These cover how the reward is calculated, when it is paid, and whether the holder has a say in running the company.

Ordinary shares: a variable reward

An ordinary share has no fixed return. Its reward is a dividend decided each year. It depends on how much profit the company made and how much the directors choose to share out.

In a strong year the dividend can be generous. In a weak year it may be small, or nothing.

The ordinary shareholder feels the full swing of the company’s fortunes. They gain most when the company does well and receive least when it struggles.

Preference shares: a fixed slice paid first

A preference share has a dividend set at a fixed rate of the share’s nominal value. A 6% preference share of RM1 pays 6 sen a year for each share held.

On RM100,000 of such shares, that is RM6,000. The rate does not rise when profits are high or fall when they dip.

Preference shareholders are also paid before ordinary shareholders. The fixed preference dividend is settled first. In return for this priority and predictability, they give up the extra reward a booming year brings to ordinary owners.

Who is paid before whom

When profits are shared out, preference shareholders come first. Only after the fixed preference dividend is met does anything remain for the ordinary shares.

A similar order usually applies if the company is wound up. After outside creditors and lenders are dealt with, preference capital is usually repaid before ordinary capital.

The ordinary shareholder is last in line at every stage. That is why their potential reward is the largest: they receive whatever is left once everyone else’s fixed claim is met.

When a missed dividend carries forward

Preference shares come in two forms, depending on what happens when a dividend cannot be paid.

• Cumulative: an unpaid dividend carries forward as arrears. It must be paid, on top of the current year’s amount, before ordinary shareholders receive anything in a later year.
• Non-cumulative: a dividend missed in a poor year is lost and does not build up.

So cumulative preference shares give a firmer claim over time. Non-cumulative ones leave more of a bad year’s risk with the shareholder.

A say in how the company is run

Ordinary shares normally carry voting rights. Ordinary shareholders help decide matters put to the members, such as who serves as a director. Preference shares usually carry no vote, or a limited one in certain cases.

The preference shareholder accepts a quieter, more secure position and gives up much of the control. The ordinary shareholder holds both the steering wheel and the risk.

Risk and reward pull in opposite directions

The preference share is the calmer holding: a fixed rate, an earlier place in the queue for dividends and repayment, and, if cumulative, arrears that cannot be dropped. But the reward is capped, so there is no share in the upside of a spectacular year.

The ordinary share is the bolder holding. It is last for dividends and last for repayment, and its return can fall to nothing. But the ordinary shareholder captures the growth of a successful company.

Both belong to the owners

Both kinds of share are equity, and both dividends are appropriations of profit, not expenses. Neither is charged when working out profit for the year, unlike debenture interest. Both are dealt with afterwards, when the company decides how to share its profit.

On the statement of financial position, both kinds of share capital appear in the equity section, listed separately so a reader can see how ownership is divided.

If your child mixes up the fixed preference dividend and the variable ordinary one, one of our teachers can set the two side by side with worked figures. Book a trial class

Syllabus reference: Cambridge 0452 and 0985, syllabus for 2027 to 2029, sub-topic 5.3 Limited companies (page 16).