Preferred dividends paid to corporate investors are subject to the "dividends received deduction" (i.e. 80% of dividends paid are tax exempt), preferred yuields are below the yields on the firm's highest grade bonds.
Can anyone explain this?作者: johnnyBuz 时间: 2011-7-13 15:25
When a Corporate invests in Preferred Stock of another Corporate, dividends that it gets from that investment is tax exempted upto 70%, 80% or 100%, based on different conditions.
So, yield on that investment can be taken as after tax yield.
Whereas, say the same Corporate invests in debt securities of another Corporate, interest returns from that investment will be taxed. So yield on that investment would be before tax yield.
So, in order for after tax yields to be similar for both investments, yields from preferred stock are usually less than yields from highest grade bond (debt) of that corporate.作者: Londonrocks 时间: 2011-7-13 15:25
Understand. However, is that why yield are lower for preferred shares? Theoretically, yields on pfds should be higher given that bond holders normally are entitled to claims on assets of an entity upon bankruptcy or liquidation.作者: Daniel1985 时间: 2011-7-13 15:25
You are correct. Theoretically, debt holders have a superior claim on company's assets and also they could have more protection built in thru 'Indentures', which preferred shareholders dont have.
So, theoretically, preferred yields should be more than bond yields as they are bearing more risks as compared to debt holders of the same company.
But this is the case, till taxes dont come in picture.
Corporate Investors enjoy tax exemption (in US from 70% to 100%) on their 'dividends received' income.
Even for individual investors, taxes paid on dividends are about 15% in US (and tax free in many countries), whereas interest returns are taxed at their usual marginal tax rate.
So, this would be the explanation for your question. But this could change from country to country based on their tax laws for dividend and interest incomes.
