Why Preferred Shares Trade Below Common Shares, and What the Premium/Discount Means

TL;DR

• Preferred shares often trade below common shares because they carry dividend priority but have limited voting rights.
• The premium/discount rate measures the price gap between preferred and common shares as a percentage, and large gaps can indicate arbitrage attempts, liquidity problems, or regulatory effects.

Definition and key differences of preferred shares

Preferred shares give holders priority in dividend payments or capital return, unlike common shares. Conversely, most preferred shares have limited or no voting rights, so they carry fewer governance rights than common shares. Markets price that difference in rights into share prices.

Why preferred shares are often cheaper than common shares

Share prices reflect expected cash flows (dividends), rights, liquidity, and tax or regulatory factors. For example, preferred shares may have higher expected dividends due to priority, but they do not capture a governance premium because they lack voting rights. Low trading volume and wider bid-ask spreads increase the required discount by investors. For these reasons, preferred shares of the same company commonly trade cheaper than common shares.

What is the premium/discount rate and how to calculate it

The premium/discount rate is generally calculated as "(preferred price ÷ common price - 1) × 100" or the inverse depending on convention. For example, if the common share is 10,000 won and the preferred share is 8,000 won, calculating the gap from the preferred share basis gives:

• Gap = (8,000 ÷ 10,000 - 1) × 100 = -20%

A negative value means the preferred share is at a discount, a positive value means it is at a premium. Some market participants judge arbitrage opportunities by the absolute value and volatility of the rate. Calculation conventions can differ, so confirm the definition before comparing.

What happens when the premium/discount widens sharply

1) Arbitrage attempts: Large gaps can prompt simultaneous buys and sells of common and preferred shares to capture the difference. Transaction costs, borrow fees, taxes, and settlement risk must be considered.
2) Liquidity and price discovery issues: Persistent gaps can reflect low liquidity on one side, reducing market participation and distorting price discovery.
3) Regulatory and disclosure factors: Changes in dividend policy or voting regulation can cause sharp moves in the gap. Check up-to-date rules and tax rates with brokerages or tax authorities.

Common misconceptions and checklist

• Misconception: Preferred shares are always cheaper. In reality, some companies and periods show preferred shares trading at a premium.
• Misconception: A wide gap guarantees profit. Arbitrage carries costs and risks.
• Checklist: Confirm the calculation method for the gap, transaction costs, dividend policy, float, and the extent of voting restrictions.

Example calculation (hypothetical)

Assumption: Common 1 share = 50,000 won, Preferred 1 share = 40,000 won

• Gap = (40,000 ÷ 50,000 - 1) × 100 = -20%

This implies the preferred share is 20% discounted, but actual arbitrage requires accounting for trading fees, borrow costs, and taxes.

This article is for information only and is not investment advice.