Cumulative preferred stock is a type of preferred equity that guarantees fixed dividend payments and accumulates unpaid dividends to be paid in the future before any dividends can be issued to common shareholders.
Cumulative preferred stock is a class of preferred shares issued by a corporation that provides shareholders with the right to receive dividends at a fixed rate, and if the company is unable to pay dividends in any period, these unpaid dividends accumulate and must be paid out in the future before common shareholders receive any dividend. This feature protects investors by ensuring that missed dividend payments are not permanently lost but rather carried forward as arrearages. In finance and wealth management, cumulative preferred stock is used by companies as a flexible financing tool that blends characteristics of both debt and equity. It offers investors a higher claim on dividends than common stockholders and priority over common equity in liquidation scenarios. These shares generally do not carry voting rights, but they are preferred when it comes to dividend payments and claims on company assets. The cumulative feature contrasts with non-cumulative preferred stock, where missed dividends are not owed in the future. This makes cumulative preferred stock attractive for income-focused investors seeking more predictable dividend income streams and some downside protection through dividend accrual.
Understanding cumulative preferred stock is critical for portfolio construction and income strategy within family offices and wealth management contexts. These shares can deliver steady dividend income which is particularly appealing for investors who value reliable cash flow, such as those managing wealth for multiple generations or funding ongoing philanthropic activities. From a governance and tax perspective, the cumulative dividend obligation influences the company's financial structure and dividend policy, impacting the timing and amount of distributions that ultimately flow to investors. Additionally, since unpaid dividends accumulate, tracking arrearages is necessary for accurate reporting and valuation. Cumulative preferred stock can also play a role in tax planning by affecting the character and timing of dividend income, which can be preferentially taxed compared to interest income.
Consider a corporation issuing cumulative preferred shares with a $100 par value and a fixed 5% annual dividend rate, meaning $5 per share annually. If the company skips dividend payments for Year 1 and Year 2 due to cash constraints, the unpaid dividends of $10 per share ($5 for each year) accumulate. In Year 3, before any dividends can be paid to common shareholders, the company must pay the $10 arrearages plus the current $5 dividend, totaling $15 per share to cumulative preferred shareholders.
Non-Cumulative Preferred Stock
Non-cumulative preferred stock differs from cumulative preferred stock in that unpaid dividends do not accumulate. If a dividend payment is missed, the company is not obligated to pay those dividends in the future, which may increase income volatility for investors compared to cumulative preferred shares.
What happens if a company misses a dividend payment on cumulative preferred stock?
Missed dividends on cumulative preferred stock accumulate as arrearages and must be paid in full before the company can pay any dividends to common shareholders.
Do holders of cumulative preferred stock have voting rights?
Generally, holders of cumulative preferred stock do not have voting rights, except in certain circumstances typically related to unpaid dividend arrearages exceeding a specific threshold.
How is cumulative preferred stock different from non-cumulative preferred stock?
Cumulative preferred stock requires that missed dividends be paid in the future, while non-cumulative preferred stock does not accumulate unpaid dividends, meaning missed payments are not owed later.