Brazilian preferred stocks

Preferred stock is a type of stock that has preference over common stocks regarding the payment of dividends. In international markets, preferred stock is considered a hybrid instrument, a shareholder’s equity security with fixed income characteristics.

In Brazil, what we call preferred stock is a common stock with different voting rights. Companies in other stock markets may create Class B stocks with superior or inferior voting rights. Brazilian preferred stocks (i.e. Class B stock) is a type of stock which has fewer or none voting right, having some kind of advantage over common stock (Class A stock, if you will) in receiving dividends.

The Lei das Sociedades Anônimas (Limited Companies Act) states three possibilities:

A) Priority of receiving mandatory dividends (another specific characteristic of Brazilian stock market), the dividend to preferred stock has to be at least 3% of the company's shareholder’s equity.

B) Right to receive dividends at least 10% higher than those paid to common stocks

C) Tag Along of at least 80% and same dividends distributed to common stocks

In the case A, the company first decides how much to pay in dividends. Then first the preferred shareholders receive 3% of the company shareholder’s equity in dividends. If there are more dividends to be paid, the same amount is paid to common stocks. If there are more dividends to be paid, then it is equally distributed to common and preferred stocks.

The company’s by-law must state what the advantages granted to preferred stocks are.

Examples:

A) Petrobras (NYSE: PBR.A to common stock and NYSE:PBR.B to preferred stock) states that preferred stocks have the right to receive at least 5% of preferred stock capital and at least 3% of their shareholder’s equity

B) Bradesco (NYSE:BBD to preferred stock) grants 10% higher dividends to preferred stock. The bank also grants 80% Tag Along (Case C) but it is because of BM&F Bovespa’s special listing segment rules (Nível 1, i.e., Level 1). In a future text I will write about those special segments.

C) Itaú-Unibanco (NYSE: ITUB to preferred stock) grants to preferred stock Tag Along of 80%. Additionally, the company grants to preferred stocks the priority of receiving the yearly minimum dividend. The dividends paid to common and preferred shares are the same.

Additionally, preferred stocks have priority if the company is liquidated. Some companies grant voting rights to preferred stock. Vale (NYSE: VALE to preferred stock) gives to preferred stock the same voting rights except for elections to Board of Directors (Conselho de Administração in portuguese). Vale’s minority shareholders may, in a separated election, elect or remove one member to Board of Directors if they represent at least 15% of the total common shares or 10% of preferred shares. Preferred shareholders have the right to elect or remove one member to Fiscal Council.

Vale has another special case for preferred stocks. There is a “special” preferred share owned by the Brazilian Government that has veto rights in some subjects. Consult the company’s by-law, article 7, to see what those subjects are.

Law nº 6.404 (Lei das Sociedades Anônimas) limits the preferred stocks to 50% of the company’s capital. Brazilian companies usually have a concentrated ownership and preferred shares are issued to raise capital without losing control rights. Because of this, the law restricts the number of preferred stocks that may be issued.

Since 2004, Brazilian companies that go public are usually choosing a capital structure with common stocks only. It is an important change in Brazilian stock market and a great advance in terms of Corporate Governance. More about those subjects in future texts in this blog.