The Difference Between Preferred &amp; Common Stocks in Europe from the Market Perspective

Tomas Brabenec,Frantisek Poborsky,Sean Patrick Saßmannshausen

doi:10.7441/joc.2020.03.04

Abstract

Companies listed on the stock market must devote a great deal of attention to their market position. They must increase their competitive advantage in the undeniably key process of the issuance of stocks. As the issuance of preferred stocks has increased after the last crisis and in the current period of low interest rates in Europe, they are becoming more favoured investment instruments, we decided to analyse the real properties of preferred stocks in Europe in order to increase the efficiency of joint-stock companies. Using a dataset comprising all companies having both common and preferred stocks issued and traded on European markets between 2009- 2016, we determined the relationship of risk (measured by beta coefficients) and price volatility among common and preferred stocks and bonds in Europe. Our findings show beta coefficients of preferred stocks as systematically lower than beta coefficients of common stocks. Considering a difference of up to 10% as negligible, however, preferred stocks showed a similar or higher beta coefficient than corresponding common stocks of the same company in 53% of cases, whereas for 33% of cases, the difference is only ±10%. Coefficients of variation in prices showed a similar relationship, with only a negligible portion of preferred stocks bearing fixed (stable) dividends. This result implies that currently traded preferred stocks in Europe in fact do not possess such characteristics they are typically said to have, and in many cases they incur as comparable a risk as do common stocks. This essential information should help to increase the efficiency and competitiveness of joint-stock companies.

Highlights

In this paper, we deal with preferred stocks
We calculated the beta coefficients for the preferred stocks and the common stocks included in our sample, and irrespective of what parameters were used for the beta coefficient calculation (5 year and 2 year periods and monthly/weekly yield were considered), the conclusions were almost identical: It is not true anymore that preferred stock beta coefficients are always lower that common stock beta coefficients (as opposed to Han (2010))
There were 20% of the cases with the preferred stock beta coefficient being significantly lower than the common stock beta coefficient

Summary

Introduction

According to Hašková et al (2019), from the corporate finance perspective, preferred stocks are an favoured instrument for some investors, due to their character, i.e. the services that preferred stocks can provide as a special type of equity. For many investors and corporate finance managers, preferred stocks can serve ideally as a source of equity with stable dividends with typically a limited impact on company decision-making. Preferred stocks can serve optimally for European companies in which owners leaving executive positions wish to secure their successors, and for European investors who are searching for equity non-minority instruments without participation in the decision-making process (Horák & Krulický, 2019). From the valuation perspective, preferred stocks are not a typical asset, so they have to be dealt with carefully. The value of preferred stocks is not entirely in line with the value of the business, so traditional approaches based on company DCF valuation converted to the per share basis do not bring meaningful results (Vrbka & Rowland, 2017)

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Conclusion