Are preferred shares capital stock or liabilities?


IS there a limit to the issuance of preferred shares by stock corporations? Only officials of the Securities and Exchange Commission should know the answer to this.
Due Diligencer is posing this query because at the rate listed companies are tapping preferred shares to raise money, SEC officials may want to take the initiative of informing the public how these issuances affect a company’s assets and liabilities.

What Due Diligencer knows so far is for an issuer to have enough amounts of retained earnings when buying back its own shares on the open market. ‘Enough’ here should mean the surplus should be able to provide for allocation for the buyback acquisition cost.

But what happens to the public when a listed company spends only so much in buying back its own shares to the extent of its retained earnings? Will the SEC allow this exercise that in the end says the share buyback would leave nothing left for declaration and distribution as dividend either in cash or in stock?

Before I go any further, I think the SEC should define preferred shares for the public to understand what they really are—that they are part of the capital under stockholders’ equity. Should these shares continue to form part of a company’s capital when these are, in reality, liabilities? Just take a look at how they are paid and not how they are treated in financial filings.

Some years ago, I raised this issue during a seminar conducted by SGV & Co. Should preferred shares continue to be treated as part of capital and not as liabilities—or public borrowings?

Perhaps because the exchange between the lecturer and me happened many years ago, I am not able to recall now his exact response. All I remember today is his suggestion then that someday the rule would change. Unfortunately, it has not.

Confusing, isn’t it?

If preferred shares are capital as CPAs and company lawyers saw them then and still see them today, is it correct for their holders to be entitled to a “dividend,” measured in percentage? Does this not make these shares liabilities just like any other borrowings made by companies? Since borrowings, after all, are liabilities, the borrowers pay interest at such rate as may have been agreed upon. The only difference, of course, would be in the definition of earnings. While preferred shares earn a “dividend” based on a stated interest rate, which makes it a misnomer, borrowings are charged interest based on agreed rate or rates.

The doubting public may continue to raise more questions on the use of preferred shares as a fund-raising exercise. But as far as investors, particularly the small ones among them, are concerned, a few, if not many, of them, may not be aware at all that when these stocks are redeemed, they end up as treasury shares under stockholders’ equity. They are not immediately retired because they are reserved for future reissuance without seeking the burdensome and expensive procedures they have to undergo when applying for approval by the SEC.

Nonetheless, when the public feel helpless in understanding certain corporate acts undertaken or implemented by listed companies, they should know there is an SEC to turn to for help. It is easy to know who, among its officials, could be approached for succor. All they have to do is access, which would guide them who among the SEC officials could assist them. I have long been relying on SEC sources for information but all of them have already retired from the service. Their retirement, though, did not prevent me from developing other “teachers” from among SEC insiders.

Like me, you also should be able to avail yourselves of the SEC’s assistance in case you need it. Don’t be afraid of them but don’t ever think they are ready to help you just because you, as taxpayers, are paying them their salaries.

As I made this suggestion, I am reminded to seek the SEC guidance in understanding retained earnings. Yes, the amount represents accumulated net profits—or pool of profits—which could be easy to interpret in case of a unit of a conglomerate. What about that of parent company? How much of its retained earnings reported in its consolidated financial filings belong to it? How much of its retained earnings should be taken into account in allocating a portion of the surplus for the shares it had bought back that it eventually resold at premiums?

It is up to the SEC to make the full disclosure of retained earnings of a parent company easily understandable by the public by requiring it to make a separate quarterly posting clearly stating the amount of surplus that it actually owns. Said filing should exclude equities or its share from the earnings of subsidiaries that have yet to declare them as dividend. Isn’t this easier for the public to appreciate than directing them to footnotes explaining the entry or entries under stockholders’ equity.

In short, holding companies should report its own quarterly financial performance and should not make the numbers they show in consolidated reports a guessing game among investors.


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1 Comment

  1. Cres Malifier on

    This question seems only to be an issue here in the Philippnes. WEhy? Because the powerful corporations are the bosses of the SEC officials?