Cumulative Preferred Stock

Cumulative preferred stock is a feature of preferred stock under which any dividend the corporation skips, or omits, does not simply disappear; instead it accumulates and must be paid in full to the preferred stockholders before the corporation is permitted to pay any dividend at all to its common stockholders. This protective feature makes cumulative preferred stock meaningfully safer for investors than its non-cumulative counterpart, since a corporation under financial strain cannot simply skip preferred dividends indefinitely without consequence to common shareholders down the road.

Dividends that have been skipped on cumulative preferred stock are called dividends in arrears, and while they build up as a real obligation the corporation must eventually satisfy, they are generally not recorded as a formal liability on the balance sheet, since no dividend is actually owed until the board of directors formally declares one. Instead, dividends in arrears must be disclosed in the notes to the financial statements, so that readers, particularly common stockholders and potential buyers of the stock, are aware of exactly how large the preferred claim has grown before any common dividend could legally be paid.

Without the cumulative feature, a corporation facing a difficult year could simply skip a preferred dividend and move on, with the preferred stockholders having no further claim to that missed payment once a later, more profitable year arrives. The cumulative feature changes that dynamic entirely: it forces the corporation to catch up on every missed preferred dividend before resuming payments to common stockholders, which gives preferred investors meaningfully stronger protection and is one of the main reasons cumulative preferred stock typically trades at a premium, or can be issued with a somewhat lower stated dividend rate, compared with equivalent non-cumulative preferred stock.

Non-cumulative preferred stock requires the corporation to pay only the current year's dividend, with no obligation whatsoever regarding previously skipped dividends, which makes it considerably riskier from an investor's perspective during periods when a company's earnings are weak or volatile. Most preferred stock issued by established corporations today is cumulative, since investors generally demand this protection in exchange for accepting preferred stock's otherwise fixed, limited upside compared with common stock.

A corporation with a substantial backlog of dividends in arrears on its cumulative preferred stock effectively cannot pay any dividend to common stockholders until that entire backlog is cleared, which can mean common stockholders go without dividends for an extended period even after the company's financial performance has genuinely recovered. This is why potential buyers of a corporation's common stock specifically check for any disclosed dividends in arrears on outstanding cumulative preferred stock before assuming that improving profitability will translate quickly into a resumed common dividend.

A corporation with 10,000 shares of $100 par, 6% cumulative preferred stock owes $60,000 in preferred dividends annually. If the corporation skips this dividend entirely for two consecutive years before resuming payments, it accumulates $120,000 in dividends in arrears, all of which must be paid in full, along with the current year’s own $60,000 dividend, before a single dollar can be distributed to common stockholders — a combined $180,000 preferred obligation the corporation must clear before common shareholders see anything at all.