Preferred shares function differently than common shares in that investors benefit most from the promised dividends rather than from the growth of the company. Preferred shares also have priority over common shareholders in the event the company declares bankruptcy. However, some preferred shares have different qualities that make them more attractive to investors, such as carrying over unpaid dividends.
Calculating Preferred Dividend Payments
Preferred share dividend payments are determined by multiplying the par value of the stock by the dividend percentage rate. The price that an investor pays for the preferred shares has no effect on the dividends paid. For example, if a preferred share has a par value of $10 and a dividend rate of 11 percent, the preferred share dividend would be $1.10. You can find the par value and the dividend rate on the stock certificate or by asking your broker.
Dividend Payment Procedure
Each year, the company issuing the preferred stock has the option to declare dividends. The company can elect not to pay any dividends to either common or preferred shares. However, all preferred share dividends must be paid before any common share dividends can be paid. For example, if preferred shareholders are owed $400,000 in dividends based on the dividend rate and par value, the company could elect to pay no dividends at all. However, it can't choose to pay a dividend to common shareholders without paying the full $400,000 to preferred shareholders.
Cumulative Versus Non-Cumulative
If a corporation decides not to pay a dividend, preferred shareholders will be entitled to that dividend at the next dividend payment if their shares are cumulative. However, if the shares are non-cumulative, the unpaid dividend does not carry over. For example, if the corporation owed $400,000 to cumulative preferred shareholders, but elected not to pay a dividend, the next time a dividend came due, the corporation would have to pay the $400,000 owed to the cumulative preferred shareholders before paying any dividends for the next period. However, if the corporation skipped a dividend payment to non-cumulative preferred shares, the corporation would have no obligation to pay the skipped dividends at a later date.
Participating Versus Non-Participating
Participating preferred shares receive a portion of the common stock dividends as well as the promised preferred stock dividends. Non-participating preferred shares are limited to only the dividend promised based on the par value and dividend rate. This distinction does not affect whether the preferred stock is cumulative or non-cumulative.
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