Stockholders purchase shares of stock as an investment. They want to increase the value of their investment either through the increase in market value of the stock or by receiving dividend income from the corporation. Each corporation chooses whether or not to issue dividends. Some companies issue dividends every quarter. Other corporations never pay dividends, choosing to reinvest earnings into the company instead. Still other corporations pay dividends sporadically. Skipping dividend payments has several results.
Purpose of Dividends
Stockholders face many different options for investing money. They invest in bonds when they want guaranteed income through interest payments with a return of their full investment at maturity. They invest in bank accounts when they want no risk on their money. They invest in stock to increase the value of the investment and feel comfortable with a higher risk level. These investors often choose to invest in companies that pay dividends. Dividends provide a return to the stockholders. They provide a method of rewarding stockholders for investing their money with the company.
One effect that occurs when a company chooses not to pay dividends considers the financial perception of the stock market. If a company pays regular dividends and chooses to skip one of the regular dividend payments, financial analysts and stockholders worry about the reason why the company skipped the payment. They raise concerns about the company's financial health. The stock price generally drops after this occurs.
Another effect considers the impact of skipping a dividend on the company's reputation. Investors lose faith in a company who paid dividends reliably and decides to skip a dividend payment. The company's reputation to manage its money falters.
Cumulative Preferred Dividends
Some companies issue cumulative preferred stock in addition to common stock. Cumulative preferred stock requires the company to pay all outstanding preferred dividends prior to paying any dividends on common stock. If the company skips paying dividends, it will need to pay the preferred dividends it skipped along with future preferred dividends before the common stockholders receive any dividend income. As this continues, the common stockholders fall further down in line to receive dividend payments.
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