This magnification of credit risk for preferred stocks occurs essentially because of their payoff structure. If the firm is liquidated at a low value, all other debt holders are paid first and only then are the preferred holders paid. This credit risk is not rewarded with participation in the firm’s upside as it is for common equity holders. Hence, when firm value becomes low, preferred stocks are more acutely exposed to credit risk than common stocks holders. In such a situation of a very low firm value, preferred stock prices can experience declines that are greater than that of.
