Cumulative preferred stock

Definition

Cumulative preferred stock is a type of equity security that guarantees the payment of dividends to shareholders, even if the company misses dividend payments in the past. This means that if a company skips a dividend payment, it must pay all missed dividends in the future before any dividends can be paid to common shareholders. Cumulative preferred stock provides a layer of security for investors, making it an attractive option for those seeking consistent income from their investments.

5 Must Know Facts For Your Next Test

1. Cumulative preferred stockholders have the right to receive all past due dividends before any payments are made to common stockholders.
2. If a company is unable to pay dividends in a given period, cumulative preferred stock allows investors to accumulate these unpaid dividends as 'dividend arrears'.
3. This type of stock is often less risky than common stock because it provides more predictable income through fixed dividend payments.
4. In times of financial distress, companies may suspend dividend payments on both common and preferred stock, but cumulative preferred shareholders must still be paid back before common shareholders once payments resume.
5. Cumulative preferred stock can be either convertible or non-convertible, with convertible options allowing investors to exchange their preferred shares for common shares under specific conditions.

Review Questions

• How does cumulative preferred stock provide financial security to investors compared to common stock?
  • Cumulative preferred stock offers greater financial security to investors because it ensures that they will receive any missed dividend payments before common stockholders get anything. This structure makes cumulative preferred shares appealing to investors looking for stable income, as they are prioritized for payouts even during financial difficulties. In contrast, common stockholders may not receive dividends at all if the company's profits are insufficient or if the board decides to reinvest earnings instead.
• Discuss the implications of dividend arrears for cumulative preferred stockholders and how this affects their investment strategy.
  • Dividend arrears for cumulative preferred stockholders mean that any missed dividend payments accumulate and must be paid before common shareholders receive their dividends. This feature affects investment strategy as it attracts investors seeking reliable income streams, particularly during economic downturns. Investors might consider holding cumulative preferred shares as a defensive investment option since these stocks have a contractual obligation to pay accrued dividends, providing a sense of stability in uncertain markets.
• Evaluate the impact of financial distress on a company's ability to manage its cumulative preferred stock obligations and how this affects overall corporate governance.
  • Financial distress significantly impacts a company's ability to meet its obligations related to cumulative preferred stock, as failing to pay dividends can lead to accumulated arrears. This situation forces the management to prioritize cash flow and operational efficiency while navigating shareholder expectations. Additionally, if companies frequently suspend dividends on cumulative preferred shares, it may raise concerns among investors about management decisions and corporate governance practices. Such scrutiny can influence future capital raising efforts and investor confidence, potentially affecting the company’s long-term viability.

Related terms

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

Dividend Arrears: The amount of unpaid dividends on cumulative preferred stock that must be paid out before any dividends are distributed to common shareholders.

Common Stock: A type of security that represents ownership in a corporation, granting shareholders voting rights and residual claims on income and assets after all debts and preferred dividends have been paid.