This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
Preferred shares came into popularity in the United States chiefly on account of their influence in railroad reorganizations. It was, and is still, customary in severe reorganizations to cut down the fixed obligations of the corporation by compelling some of the junior bondholders to accept preferred shares instead of their bonds. By making this exchange, the former-bondholders retain their claims upon the income of the corporation, but the claim is made simply a preference instead of a positive obligation. Except in reorganizations, preferred shares have been very little used in the United States by railroad corporations.
An entirely different use has been found for them, however, in connection with large industrial corporations. It has become customary to represent the tangible assets and the current earning power of corporations by bonds and preferred shares, and to represent the intangible assets and expected income by common shares. Nearly all of the large industrial corporations formed in the last twenty years have followed this policy. One of the striking features of the stock market during the last five years has been the successful floating of a large number of preferred share issues by the smaller industrial corporations. Sometimes these shares are sound, sometimes unsound. In either case it seems to be fairly easy to dispose of them; the buying public has evidently been educated to like and approve industrial preferred shares.
Preferred shares are sometimes used also to distribute voting power in such a way as to give control to a comparatively small group. The Rock Island preferred shares, referred to above, were of this kind.
In the smaller corporate organizations, preferred stocks are often used to make the adjustments necessary in the incorporation of partnerships. If it is desired to give equality of voting right, the partner having an excess of capital is given a similar excess of stock in non-voting preferred stock. Or, common stock may be given to those who have the management, and preferred stock may be given to those who are to retire from the business. By means of the two kinds of stock, almost any desired difference of investment or power of control may be secured.