Reference no: EM13829620

Common stock financing is often considered the safest form of financing, as the issuing firm is under no obligation to pay dividends. Owners of common shares assume this uncertainty in the hope of favorable returns. Debt financing, assuming reasonable debt levels and good credit, is often the least expensive form of capital. This is because owners of bonds have legally enforceable claim on company assets, and thus require a lower rate of return. Plus, interest payments are tax deductible.

Then we have preferred stock financing. Owners of preferred stock do not enjoy the same upside as common shareholders. Preferred shareholders claims on company assets are below the claims of creditors. As a result, owners of preferred shares demand higher rates of return than bondholders. Plus, the firm does not get to write off the dividends paid to preferred share holders, making the after tax cost of preferred shares even more expensive relative to bonds. Yet large corporations issue preferred shares all the time. In your opinion, why is this? What is the argument for issuing preferred shares? Why not create a capital structure made solely of bonds and common stock?