Cumulative preferred stock

Definition

Cumulative preferred stock is a type of preferred equity security that entitles its holders to receive dividends that have been missed in the past before any dividends can be paid to common stockholders. This means if a company cannot pay dividends in any given year, those unpaid amounts accumulate and must be paid out to cumulative preferred shareholders before any payments are made to common shareholders in the future. This feature provides an additional layer of security for investors, making cumulative preferred stock attractive in uncertain financial conditions.

5 Must Know Facts For Your Next Test

1. Cumulative preferred stock ensures that shareholders receive all their entitled dividends even if payments are temporarily suspended due to financial issues.
2. If a company issues both cumulative and non-cumulative preferred stock, cumulative preferred shareholders have priority in receiving backlogged dividends before any distributions to common shareholders.
3. Cumulative preferred stock is particularly appealing during times of economic downturns when companies may struggle to maintain regular dividend payments.
4. When a company is liquidated, cumulative preferred shareholders have a higher claim on assets than common shareholders, but they still rank below debt holders.
5. The ability of cumulative preferred stock to accumulate unpaid dividends makes it less risky compared to non-cumulative preferred stock for investors seeking income.

Review Questions

• How does cumulative preferred stock provide advantages to investors compared to non-cumulative preferred stock?
  • Cumulative preferred stock offers significant advantages over non-cumulative preferred stock by ensuring that unpaid dividends accumulate and must be paid before any dividends can go to common shareholders. This means that if a company faces financial difficulties and temporarily suspends dividend payments, cumulative preferred shareholders will eventually receive their missed payments once the company resumes paying dividends. In contrast, non-cumulative preferred shareholders lose any unpaid dividends, making cumulative preferred stock a safer investment for those looking for reliable income.
• Evaluate the impact of cumulative preferred stock on a company's capital structure and its implications for dividend policy.
  • Cumulative preferred stock plays an important role in a company's capital structure by providing a fixed income security that can attract investors looking for stable returns. The obligation to pay accumulated dividends can influence the company's dividend policy, as management must prioritize these payments over distributions to common shareholders. This requirement can limit the company's flexibility during financial hardships, as it may need to retain earnings or raise capital to fulfill its dividend obligations to cumulative preferred shareholders.
• Analyze how economic fluctuations affect the desirability of cumulative preferred stock among investors, especially during market downturns.
  • Economic fluctuations significantly impact the desirability of cumulative preferred stock. During market downturns or periods of uncertainty, investors often seek safer investment options that provide predictable income streams. Cumulative preferred stock becomes increasingly appealing as it guarantees that any missed dividends will eventually be paid, offering a level of protection against potential losses. This characteristic can lead to increased demand for cumulative preferred shares as investors prioritize financial security, which may result in higher valuations and lower yields compared to non-cumulative alternatives.

Related terms

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

Dividends: Payments made by a corporation to its shareholders, usually derived from profits, which can be distributed in cash or additional shares.

Non-Cumulative Preferred Stock: A type of preferred stock that does not allow for unpaid dividends to accumulate; if dividends are missed, they are lost and do not need to be paid later.