Participating preference share

Preference shares sit between equity and debt: they rank above equity for dividends and for a share of assets if the company winds up, but do not usually carry voting rights. Most preference shares pay a fixed dividend and nothing more.

A participating preference share is the exception. It still gets its fixed dividend, but it can also share in extra upside — a second, additional dividend that kicks in when some pre-agreed condition is met, such as the company's profits, or the dividend paid to ordinary equity, crossing a threshold.

The workbook's definitions, side by side: "A non-participating preference share is one in which a dividend is paid, usually at a fixed rate, and not determined by a company's earnings. Participating preference share gives the holder the right to receive specified dividends plus an additional dividend based on some pre-specified conditions. Participating preference shares can also have liquidation preferences upon a liquidation event."

Participation is one of three independent dimensions the workbook lists for preference shares, each of which can combine with the others: cumulative or non-cumulative (whether an unpaid dividend rolls forward or is simply lost), participating or non-participating (whether there is upside beyond the fixed rate), and convertible or not (whether the shares can later become equity shares). The workbook names four cumulative/participating combinations explicitly — cumulative participating, cumulative non-participating, non-cumulative participating, non-cumulative non-participating — showing that participation and cumulation are graded independently rather than being the same choice.

Illustrative figures — the workbook gives no rates. Deccan Industries Ltd issues participating preference shares of Rs 100 face value carrying a fixed dividend of 8% p.a., with a participation clause entitling holders to an additional dividend equal to any amount by which the equity dividend rate exceeds 8%.

In a strong year, Deccan's board declares an equity dividend of 14%. A participating preference shareholder receives the base 8%, plus the 6-percentage-point excess over the threshold, for a total of 14% — matching the equity rate that year. A non-participating preference shareholder in the same company, holding the same face value, receives only the fixed 8%, regardless of how generous the equity dividend turns out to be.

If the company later winds up, the participating shares' liquidation preference may also entitle their holders to a further share of the surplus after preference capital is returned — a feature a plain non-participating share would not carry.

Chapter 3 (Investing in Stocks), section 3.4, introduces preference shares and their participating/non-participating, cumulative/non-cumulative and convertible variants together. Expect a matching or definitional question distinguishing participating from non-participating, and occasionally a question on the four cumulative-participating combinations.

• Participation is about the size of the dividend, not about voting rights. A participating preference share still generally carries no vote, unless the company's articles say otherwise.
• Cumulative and participating are two separate, combinable features, not the same thing — a share can be cumulative non-participating (unpaid dividends roll forward, but there is no upside beyond the fixed rate) or any of the other three combinations.
• Convertibility is a third, independent dimension — a participating share is not automatically convertible into equity, and a convertible share is not automatically participating.
• Preference shares generally rank above equity but below debt for both dividends and a winding-up distribution — participation does not change that ranking.