Redeemable Preference SharesDefined along with Examples

Written By:
Adiste Mae

What are Redeemable Preference Shares?

When preferred shares of stocks are issued to shareholders, a call option may be embedded in them.

These types of preferred stocks are called Redeemable Preference Shares because the company has the option to redeem them later.

They do not have a maturity date and are retired by the company.

When the preference shares are retired, the preference shareholders are paid a special sum as stated in their investment. 

When Redeemable Preference Shares are issued, preference shareholders are made aware of the terms of redemption. 

Redeemable Preference Shares actually provide an advantage to the company because when the value of the stocks decline, they have the option of redeeming the shares and refinance them at a lower dividend rate, or they can repurchase them. 

Understanding Redeemable Preference Shares

Suppose a company issues redeemable preference shares with a call option set at $5,000 and trades at the market for $6,000.

In this scenario, when the call price is less than the market price, the company has the option of repurchasing the preference shares issued.

If they are not able to repurchase it, they always have the option of redeeming the shares. 

Example

XYZ Corporation issued redeemable preference shares with a face value of $50 each.

In the redemption clause, the redemption period is 10 years with a redemption amount of $100 each.

But after 3 years, XYZ Corporation has decided to buy back the preference shares, and the market value is already $150 per share.

Instead of repurchasing, the company has the option of redeeming the shares for $100, which is a lower amount as compared to the current market value. 

Advantages and Disadvantages of Redeemable Preference Shares

Advantages of Redeemable Preference Shares

Among the advantages for issuing redeemable preference shares are as follows:

Option to Repurchase or Redeem Shares

Market conditions change from time to time. When companies issue redeemable preference shares, they can choose to either repurchase the shares or redeem them, depending on what is more advantageous for the company. 

Increases Earnings Per Share (EPS) of the Company

The Earnings Per Share (EPS) increases when the shares are redeemed by the company because the total number of shares decreases. Redemption happens when the company has decided to pay the shareholders. 

Increases Share Value for Existing Shareholders

Shares that pay coupon rates (higher than the current dividend yield for the equity share) are removed when companies redeem preference shares from stockholders. As a result of this, the share value for existing shareholders increase. 

Disadvantages of Redeemable Preference Shares

Although redeemable preference shares provide advantages, there are also disadvantages to it such as the following:

• Share redemption is only allowed at a time predetermined upon its issuance. 
• Share redemption is only a sound option when the call price of the shares is lower than the market price.  If not, the company would be better off repurchasing the shares. 

Limitations of Redeemable Preference Shares

Given its advantages and disadvantages, there are also limitations as to the use of redeemable preference shares:

• The option to redeem shares is only possible when the company has earlier issued redeemable shares. In the absence of this, the company will not have the option to redeem its shares.
• Redeeming shares is not entirely up to the company. The company must also wait for the time when it can exercise the option to redeem the shares, or it should wait when it is advantageous for the company to do so. 

Conclusion

Companies having the option to redeem preference shares prove to be advantageous for different reasons.

It allows the company to choose whether to repurchase or redeem depending on market conditions, to rid itself of coupon rates that are high-paying, to increase the earnings per share, and in turn, increase the share value of the company by decreasing the total number of shares outstanding during share redemption.