Definition of Cumulative Dividend
A cumulative dividend is a key feature typically found in preferred stock. It guarantees that if a corporation misses paying a dividend, the company is obligated to pay all missed dividends before any dividends can be distributed to common stockholders. This means that cumulative dividends accumulate (hence the name) if they are not paid when they are due, ensuring the preferred stockholders receive their full dividend amount eventually including arrears.
Key Aspects:
- Priority in Payment: Cumulative dividends must be paid out before any dividends can be paid to common shareholders.
- Arrears: Dividends not paid on their scheduled date are carried forward as arrears, which will be paid out in the future.
- Preferred Stock: Commonly associated with preferred shares, a class of ownership with both debt-like and equity-like features.
Examples
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ABC Corporation:
- ABC Corporation has issued preferred stock with a cumulative dividend feature. In 2022, due to financial hardship, they skipped the annual dividend payment of $2 per share. In 2023, they recover. Before any dividends can be distributed to common shareholders in 2023, ABC Corporation must first pay $2 per share for 2022 and regular 2023 dividends to preferred shareholders.
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XYZ Ltd.:
- XYZ Ltd. pays a quarterly cumulative dividend of $1 per preferred share. If the company skips a dividend in Q1 and Q2, by Q3, they need to pay $3 per share ($1 from Q1, $1 from Q2, and $1 from Q3) before addressing payments to common shareholders.
Frequently Asked Questions
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Are cumulative dividends mandatory? Not all preferred stocks have cumulative dividends. It’s a specific feature that must be outlined in the issuing agreement.
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What happens if a company fails to pay cumulative dividends? The unpaid dividends accumulate and must be paid in subsequent years before any common dividends can be issued.
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Do cumulative dividends impact common shareholders? Yes, common shareholders cannot receive dividends until cumulative dividends owed to preferred shareholders are fully paid.
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Can cumulative preferred stock be converted to common stock? It depends on the terms outlined by the company; some preferred stocks can be converted, while others cannot.
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Do cumulative dividends accrue interest? Generally, cumulative dividends do not accrue interest; they simply accumulate until paid.
Related Terms
- Cumulative Preferred Stock: Preferred stock providing a right to receive dividends in arrears before any dividends can be paid to common stockholders.
- Non-Cumulative Dividend: Preferred dividend whose entitlement is forfeited if not declared in the applicable period.
- Callable Preferred Stock: Preferred stock that the issuing company can repurchase at predetermined terms.
- Participating Preferred Stock: Preferred stock that may receive extra dividends contingent on the common stock dividend performance.
Online References
Suggested Books for Further Studies
- “Investing in Preferred Stocks: An Effortless Path to Professional Asset Management and Financial Success” by Doug K. Le Du
- “Preferred Stocks: The Art of Profitable Income Investing” by Kenneth G. Winans
- “Preferred Stock Investing” by Harry Domash
Fundamentals of Cumulative Dividend: Finance Basics Quiz
### What is a cumulative dividend?
- [ ] A dividend paid to common shareholders only
- [x] A dividend in arrears that must be paid before any dividends to common shareholders
- [ ] A one-time bonus dividend
- [ ] A tax-free dividend
> **Explanation:** A cumulative dividend refers to missed dividends that accumulate and must be paid to preferred shareholders before any dividends are paid to common shareholders.
### What type of stock typically features cumulative dividends?
- [x] Preferred stock
- [ ] Common stock
- [ ] Municipal bonds
- [ ] Corporate bonds
> **Explanation:** Cumulative dividends are typically associated with preferred stock, providing a guarantee that missed dividends will be paid out in arrears.
### If a company declares a $1 cumulative dividend per preferred share but misses two payments, how much must it pay before paying common shareholders?
- [ ] $1
- [ ] $2
- [x] $3
- [ ] $4
> **Explanation:** The company must pay $3 per preferred share ($1 for each of two missed payments plus $1 for the current period) before paying dividends to common shareholders.
### Are cumulative dividends the same as participating preferred dividends?
- [ ] Yes, they are the same
- [x] No, cumulative dividends are those that must be paid in arrears and participating preferred dividends may include extra distributions.
- [ ] Yes, but only in some jurisdictions
- [ ] No, because cumulative dividends can never be paid in advance
> **Explanation:** Cumulative dividends focus on guaranteeing missed payments, whereas participating preferred dividends involve potential extra dividends based on the performance of common stock dividends.
### What happens to cumulative dividends if a company goes bankrupt?
- [ ] They are paid out immediately
- [ ] They accrue interest
- [ ] They become common stock dividends
- [x] They may not be paid if there are insufficient assets
> **Explanation:** In bankruptcy, cumulative dividends are not necessarily paid if the company lacks sufficient assets; preferred shareholders may only recover funds if there are remaining assets after creditor claims.
### What does "in arrears" mean in the context of cumulative dividends?
- [x] Dividends that are unpaid and carried over to future payment periods
- [ ] Dividends paid immediately
- [ ] Dividends paid to common shareholders first
- [ ] Dividends that investors fawn over
> **Explanation:** "In arrears" means dividends that have not been paid on their due dates but accumulate and remain obligatory for payment in the future.
### Can cumulative preferred stock convert into common stock?
- [x] Some cumulative preferred stocks can be converted into common stock as per the issuing terms.
- [ ] All cumulative preferred stocks can automatically convert into common stock.
- [ ] No, cumulative preferred stock cannot be converted into common stock.
- [ ] Only upon the company's dissolution
> **Explanation:** Depending on the issuing company's terms, some cumulative preferred stock may indeed be converted into common stock.
### What is required before dividends can be paid to common stockholders?
- [ ] Board of directors meeting
- [x] Payment of accumulated cumulative dividends on preferred stock
- [ ] Settlement of company debts
- [ ] Issuance of new stock
> **Explanation:** Payment of any accumulated cumulative dividends on preferred stock is required before dividends can be paid to common shareholders.
### How does having cumulative preferred stock affect common shareholders?
- [x] Common shareholders must wait until all past dividends owed to cumulative preferred shareholders are paid before receiving their dividends.
- [ ] Common shareholders receive intermittent bonus dividends.
- [ ] Common shareholders can claim missed cumulative dividends themselves.
- [ ] Common shareholders have no effect at all.
> **Explanation:** Common shareholders have to wait for the payment of all arrears to cumulative preferred shareholders before dividends can be issued to them.
### Where can you find the terms concerning cumulative dividends?
- [ ] In the company's marketing material
- [x] In the preferred stock issuing agreement or prospectus
- [ ] In government logs
- [ ] Residential lease agreements
> **Explanation:** Terms regarding cumulative dividends are outlined in the company's preferred stock issuing agreement or prospectus.
Thank you for exploring the complex world of finance and understanding the nuances of cumulative dividends through this comprehensive guide and engaging quiz. Keep mastering your financial acumen!
