Preferred stock ­ debt or equity?

Preferred stock is often difficult to classify as debt or equity. Many researchers and analysts consider preferred stock to be a hybrid ­ similar to a liability in some respects and similar to common equity in others.

Like bonds, preferred stock has a par value. The par value is printed on the stock certificate and represents the value of the stock at the time it was issued. Preferred dividends are similar to interest payments when they are fixed and paid at regular intervals.

A company usually must pay preferred dividends before paying common dividends. However, a company may defer payment of preferred dividends. This will not lead to bankruptcy, but forgoing interest payments probably will lead to trouble.

Typically, accountants classify preferred stock as equity and list it in the equity section of the Balance Sheet. A bondholder will also consider preferred stock as having similar characteristics to common equity. However, a common shareholder will classify preferred shares as liabilities because preferred shareholders have a priority claim over the common shareholders.

For the purposes of this course, we will consider preferred stock to behave like a liability, and equity calculations will not include the value of the preferred stock. Typically, the unit of the bank in which you work will have specific instructions on how to handle preferred stock in an analysis.