Cumulative Preferred Stock

Definition

Cumulative preferred stock is a type of preferred stock that gives shareholders the right to receive any missed or unpaid dividends before common stockholders can receive dividends. This ensures that preferred shareholders are compensated for any past missed dividend payments before common shareholders receive any distributions.

5 Must Know Facts For Your Next Test

1. Cumulative preferred stock has a higher claim on a company's earnings and assets compared to common stock.
2. Preferred shareholders of cumulative stock must be paid all missed or unpaid dividends before common shareholders can receive any dividends.
3. Dividend arrearages, the accumulated unpaid dividends on cumulative preferred stock, must be paid before common shareholders can receive any distributions.
4. Cumulative preferred stock provides greater protection for preferred shareholders, as they are guaranteed to receive any missed dividend payments.
5. The cumulative feature of preferred stock can make it more attractive to investors, as it reduces the risk of missed dividend payments.

Review Questions

• Explain the key differences between cumulative preferred stock and noncumulative preferred stock.
  • The primary difference between cumulative and noncumulative preferred stock lies in the treatment of missed or unpaid dividends. Cumulative preferred stock gives shareholders the right to receive any missed or unpaid dividends before common stockholders can receive dividends. This ensures that preferred shareholders are compensated for any past missed dividend payments. In contrast, noncumulative preferred stock does not have this right, and dividends are only paid if declared by the company's board of directors for the current period. The cumulative feature of preferred stock provides greater protection and priority for preferred shareholders, making it a more attractive investment option.
• Describe the concept of dividend arrearages and its significance for cumulative preferred stockholders.
  • Dividend arrearages refer to the accumulated, unpaid dividends on cumulative preferred stock. These unpaid dividends must be paid to preferred shareholders before any distributions can be made to common shareholders. The existence of dividend arrearages is a key feature of cumulative preferred stock, as it ensures that preferred shareholders are compensated for any past missed dividend payments. This gives cumulative preferred stock a higher claim on a company's earnings and assets compared to common stock, providing greater protection and priority for preferred shareholders. The payment of dividend arrearages is a critical consideration for investors evaluating the financial strength and stability of a company that has issued cumulative preferred stock.
• Analyze the potential advantages and disadvantages of a company issuing cumulative preferred stock compared to noncumulative preferred stock or common stock.
  • The issuance of cumulative preferred stock can offer several advantages for a company, but also comes with potential drawbacks. The primary advantage is that cumulative preferred stock provides greater protection and priority for preferred shareholders, as they are guaranteed to receive any missed or unpaid dividends before common shareholders can receive any distributions. This can make cumulative preferred stock more attractive to investors, potentially lowering the company's cost of capital. However, the cumulative feature also means that the company must pay all outstanding dividend arrearages before it can pay dividends to common shareholders, which can limit the company's financial flexibility and cash flow. Additionally, the higher priority claim of cumulative preferred stock may make it more difficult for the company to raise additional equity capital in the future. Ultimately, the decision to issue cumulative preferred stock versus noncumulative preferred stock or common stock will depend on the company's financing needs, capital structure goals, and the preferences of its target investor base.

Related terms

Preferred Stock: Preferred stock is a type of equity security that has a priority claim on a company's assets and earnings over common stock. Preferred shareholders typically receive dividends before common shareholders and have a higher claim on assets in the event of liquidation.

Noncumulative Preferred Stock: Noncumulative preferred stock does not have the right to receive any missed or unpaid dividends. Dividends on noncumulative preferred stock are only paid if declared by the company's board of directors for the current period.

Dividend Arrearages: Dividend arrearages refer to the accumulated, unpaid dividends on cumulative preferred stock. These dividends must be paid to preferred shareholders before any distributions can be made to common shareholders.