Definition: A feature of some preferred stock that entitles holders to receive dividends for all quarters that have been skipped. These dividends must be caught up before any dividends can be paid to holders of common stock.
Example: BLD Realty sells 6% cumulative preferred shares for $100 per share. A few years later, with the economy doing poorly and tenants moving out of its buildings, its Board of Directors decides to skip paying dividends on these shares for the next four quarters (ie, a whole year). That’s $100 * 6%, or $6 worth of dividends skipped. This decision also prohibits it from paying dividends to its common shareholders. A year later the economy is improving, so BLD’s Board decides to reinstate the preferred dividend. The first thing it does is pay $6 to the holder of each preferred share to catch up on the skipped dividend payments.
Investeach explains: Dividends are considered payments of extra profits the company doesn’t need to hold onto. The Board of Directors of the corporation must approve their payment each quarter. If a corporation is doing poorly, the Board can elect to not pay them. Buying preferred stock that has the cumulative feature at least makes sure skipped dividends will be paid out eventually.
What puts pressure on corporations to resume paying preferred dividends? Common shareholders. Remember that no dividends can be paid to them until preferred dividends are completely caught up, and common stock is not cumulative!
Riddle me this:
1. Why is cumulative preferred stock better than just plain preferred stock?
2. Who must approve the payment of dividends?
3. Why might a corporation skip one or more dividend payments?