Noncumulative preferred stock definition
/What is Noncumulative Preferred Stock?
Noncumulative preferred stock allows the issuing company to skip dividends and cancel 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. 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 having an assured income stream. Instead, the shares are effectively the same as common stock, where the issuance of dividends is at the prerogative of the board of directors. Theoretically, investors can indirectly influence the issuance of dividends by electing a different set of directors. Understandably, few companies issue this type of shares, since investors are unlikely to buy them, except at a large 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. However, these types of terms can put a business at financial risk, and so must be considered in light of the continuing ability of the company to pay its investors.
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Example of Noncumulative Preferred Stock
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.
Noncumulative Preferred Stock FAQs
What are the risks for investors holding noncumulative preferred stock?
Investors holding noncumulative preferred stock risk losing unpaid dividends permanently when the board skips a dividend. They also face limited upside compared with common stock, possible inflation erosion of fixed returns, interest rate sensitivity, and subordination to creditors. In financial distress, recovery may be limited despite preference over common shareholders.
What is the difference between cumulative and noncumulative preferred stock?
Cumulative preferred stock requires missed dividends to accumulate and be paid before any common dividends are issued. Noncumulative preferred stock does not preserve skipped dividends, so unpaid amounts are lost. As a result, cumulative shares offer stronger dividend protection, while noncumulative shares give issuers more flexibility during periods of limited cash.