Cumulative dividends

Definition

Cumulative dividends refer to a feature of preferred stock that requires any unpaid dividends to be accumulated and paid out to shareholders before any common stock dividends are distributed. This ensures that preferred shareholders receive their entitled dividends, even if the company faces financial difficulties or chooses not to pay dividends in a given year. The cumulative nature of these dividends provides a level of security and priority for investors holding preferred stock, reinforcing its hybrid character between debt and equity.

5 Must Know Facts For Your Next Test

1. Cumulative dividends accumulate over time, meaning if a company skips a dividend payment, it must pay all missed dividends before distributing any to common shareholders.
2. Preferred shareholders with cumulative dividends often have less risk than common shareholders because they have priority in receiving payments.
3. In the case of bankruptcy or liquidation, cumulative dividends must be settled before any payments are made to common stockholders.
4. Cumulative dividends can be an attractive feature for investors seeking more stable income, especially during economic downturns.
5. Some companies may issue both cumulative and non-cumulative preferred stocks, providing investors with different risk-reward profiles.

Review Questions

• How do cumulative dividends enhance the attractiveness of preferred stock for investors?
  • Cumulative dividends enhance the attractiveness of preferred stock by providing investors with a safety net for their investment. If a company fails to pay dividends in any given year, cumulative dividends ensure that these unpaid amounts are accrued and must be paid before common stockholders receive any distributions. This added layer of security makes preferred stock appealing to risk-averse investors who seek more stable returns compared to common stock.
• Compare and contrast cumulative and non-cumulative preferred stocks in terms of dividend obligations and investor protection.
  • Cumulative preferred stocks obligate companies to pay any missed dividend payments before they can distribute dividends to common stockholders, providing greater investor protection. In contrast, non-cumulative preferred stocks do not have this requirement; if a company skips a dividend payment, those dividends are lost to shareholders without any future claims. This fundamental difference impacts the risk profile for investors, with cumulative stocks generally being seen as safer due to their guaranteed payment structure.
• Evaluate the implications of cumulative dividends on corporate financial strategy during economic downturns.
  • Cumulative dividends significantly impact corporate financial strategy during economic downturns by forcing companies to prioritize the payment of these accrued amounts when profits recover. This obligation can limit a company's flexibility in managing cash flow since they must allocate funds to cover past missed payments before investing in growth or paying common shareholders. As a result, firms might strategically consider issuing non-cumulative preferred stock during uncertain economic times to retain greater operational flexibility while still attracting investment.

Related terms

Preferred Stock: A class of ownership in a corporation that has a higher claim on assets and earnings than common stock, typically featuring fixed dividends.

Dividend Payment: A distribution of a portion of a company's earnings to its shareholders, which can be issued in cash or additional shares.

Non-cumulative Preferred Stock: A type of preferred stock where missed dividend payments do not accumulate, meaning shareholders have no claim on unpaid dividends.