What is noncumulative preferred stock?

Nearly all types of preferred stock have a cumulative dividend provision, under which the issuing company is allowed to skip dividends, but still has an obligation to eventually pay those dividends to the holders of the preferred stock. Noncumulative preferred stock is a type of preferred stock that allows the issuing company to skip dividends and which then cancels the company's obligation to eventually pay those dividends. This means that shareholders do not have a claim on any of the dividends that were not paid out.

For example, ABC Company normally issues a $0.50 quarterly dividend to its preferred shareholders. However, the board of directors feels that there is not sufficient cash flow in the third quarter to pay a dividend. Since the preferred stock is noncumulative, the company has no obligation to ever pay the missing dividend, and the holders of those shares have no claim against the company.

Usually, the issuing company cannot issue dividends to the holders of its common stock in the same year in which it has skipped paying dividends to its noncumulative preferred stockholders, though this depends upon the underlying terms associated with the stock. 

Noncumulative preferred stock is extremely rare, because it places the holders of the stock in the uncertain position of not really having an assured income stream. Instead, the shares are effectively the same as common stock, where the issuance of dividends are at the prerogative of the board of directors. Understandably, few companies issue such shares, since investors are unlikely to buy them, except at a considerable discount.

The terms associated with noncumulative preferred stock can be altered to improve the value of the stock to investors, such as by only allowing a small number of dividends to be skipped.

Related Topics

Preferred stock accounting 
What are the types of preference shares?
What is a final dividend? 
What is participating preferred stock?
What is the ex-dividend date?