Why Do Preferred Stocks Have a Face Value That Is Different Than Market Value?

A preferred stock is an equity investment that shares many characteristics with bonds, including the fact that they are issued with a face value. Like bonds, preferred stocks pay a dividend based on a percentage of the fixed face value. The market value of a preferred stock is not used to calculate dividend payments, but rather represents the value of the stock in the marketplace. It’s possible for preferred stocks to appreciate in market value based on positive company valuation, although this is a less common result than with common stocks.

Key Takeaways

• Preferred shares are a hybrid securities issued by corporations marrying certain traits of equity and fixed income investment.
• Preferred shares are issued with a face value, but this is effectively an arbitrary price chosen by the issuing company.
• Because preferred shares pay steady dividends, but lack voting rights, they will typically trade in the market for a value different from the same firm’s common shares.
• Some preferred shares are callable, which means the issuer can recall them from investors, so these will sell at a discount. Others are convertible into common shares.

Share Price vs. Bond Par Value

The par value of a fixed income security indicates the amount that the issuer will pay to the bondholder when the debt matures and must be paid back. Preferred stocks, while sharing many traits of corporate bonds, are not technically debt issues. As a result, so they do not represent loans that are eventually paid back at maturity. Some companies do issue preferred stocks with a maturity date and retract the stock on that date. The bondholder is compensated by the amount listed on the face value. Practically speaking, this is no different than a bond maturity in most cases. However, a retractable preferred stock is not a debt security like a bond.

The market prices of preferred stocks do tend to act more like bond prices than common stocks, especially if the preferred stock has a set maturity date. Preferred stocks rise in price when interest rates fall and fall in price when interest rates rise. The yield generated by a preferred stock’s dividend payments becomes more attractive as interest rates fall, which causes investors to demand more of the stock and bid up its market value. This tends to happen until the yield of the preferred stock matches the market rate of interest for similar investments.

Share Price vs. Callable Price

Some investors confuse the face value of a preferred stock with its callable value – the price at which an issuer can forcibly redeem the stock. In fact, the call price is generally a little higher than the face value. Callable preferred stocks are not the same as retractable preferred stocks that have a set maturity date. Companies might exercise the call option on a preferred stock if its dividends are too high relative to market interest rates, and they often re-issue new preferred stocks with a lower dividend payment. There is no set date for a call, however; the corporation can decide to exercise its call option when the timing best suits its needs.

In effect, the face value of a preferred stock is the arbitrarily designated value generated by the issuing corporation that must be repaid at maturity. It is significant in determining dividend payments, though not necessarily yield. The market value is the actual price at which the security trades on the open market and the price that fluctuates when yield is reacting to interest rate changes.

Primary Users of Face Value/Par Value

The face value (or par value) of a stock is primarily of interest to the following people:

• Company Issuers: When a company issues stock, the face value is often a legal requirement and is recorded in the company’s financial statements. It is used to calculate the minimum amount of equity that must remain in the business, particularly for regulatory and legal purposes. In the case of bonds, face value determines the amount repaid at maturity.
• Regulators and Legal Entities: Face value is relevant in compliance with corporate laws, especially regarding the issuance of shares. Companies must declare the face value when issuing stock.
• Investors in Preferred Stock: Preferred stock dividends are often calculated based on the stock’s face value, making it a key figure for preferred shareholders. In the event of liquidation, the face value may also determine how much preferred shareholders are entitled to before common shareholders receive anything.
• Accountants and Auditors: Accountants use face value to record equity in a company’s balance sheet, particularly in the common stock and additional paid-in capital accounts.

Note

Face value never changes, while market value often fluctuates.

Primary Users of Market Value

There’s also people who likely care more about the market value of a security. These people include:

• Individual Investors: Retail investors closely monitor market value to make decisions about buying, holding, or selling shares. It represents the actual worth of their investment at any given time.
• Institutional Investors: Similar to individual investors, hedge funds, mutual funds, pension funds, and other institutional, large-scale investors rely on market value for portfolio management, valuation, and performance tracking.
• Equity Analysts: Analysts study market value in relation to earnings, dividends, and other metrics to recommend whether a stock is undervalued or overvalued.
• Creditors and Lenders: Creditors may consider a company’s market value when assessing its financial health, creditworthiness, and ability to secure loans or issue debt.

Situations Where Par Value Equals Market Value

While rare, there are situations where the market value and par value (or face value) of a stock can be the same. These include:

1. Initial Public Offering. At the time of a stock’s IPO, the offering price may be set equal to or very close to the par value. This is more common in less developed or tightly regulated markets where par value has more significance.
2. Illiquid or Thinly Traded Stocks: For companies with very low trading volume or in niche markets, the market value may hover near the par value, especially if there is minimal demand or awareness.
3. Shares in Financial Distress: When a company’s financial health is severely compromised (e.g., approaching bankruptcy), its stock may trade at or near par value if the market sees little to no intrinsic or speculative value.
4. Preferred Stocks in Stable Markets: For certain preferred stocks, the market value often remains close to the par value because dividends are based on the par value, and there is less fluctuation compared to common stocks.
5. Regulated Utility Companies: Some utility companies issue stocks where the par value and market value remain closely aligned, as these stocks are often stable and heavily influenced by regulatory frameworks.
6. Small or Privately Held Companies: In privately held companies, shares may not have an actively traded market, so the “market value” may effectively default to the par value for accounting or transactional purposes.

What Is the Difference Between Par Value and Market Value?

Par value (or face value) is the nominal value assigned to a stock or bond by the issuing company, primarily for accounting and legal purposes. Market value is the price at which a stock is traded in the open market, determined by supply and demand, company performance, and market sentiment. While par value is fixed, market value fluctuates constantly.

Why Is Par Value Important?

Par value sets the minimum price at which a stock can be issued, ensuring legal compliance and preventing companies from issuing shares below this value. It also serves as the basis for calculating preferred stock dividends and may be used in the event of liquidation.

Who Sets the Par Value of a Stock?

The issuing company determines the par value when creating the stock, often choosing a nominal amount like $0.01 or $1.

Can Market Value Be Lower Than Par Value?

Yes, though it is uncommon. If a company faces severe financial distress or bankruptcy, its stock may trade below par value as investors lose confidence in its viability. This is very unlikely in many cases due to the answer above (the par value is usually set by the company as a very, very low amount).

The Bottom Line

Market value and par value are fundamentally different because they serve distinct purposes. Par value is a fixed, nominal value assigned to a stock or bond by the issuing company, primarily for legal and accounting reasons, such as establishing the minimum price for issuing shares. Market value reflects the current price at which a stock trades in the open market, determined by supply and demand, company performance, and broader economic factors.