What is preferred stock?

Preferred stock is a form of equity evidencing ownership in the capital stock of the issuing company that has preference rights over its common stock.  Unlike common stock, preferred stock rarely has voting rights and may not have preemptive rights; unlike bonds, it does not mature.

The preferences rights of preferred stock are generally:

• A dividend of a fixed or minimum amount payable before dividends on common stock; and
• The payment of passed (cumulative) dividends due but not yet paid before satisfying the claims of common shareholders upon the firm’s liquidation.

As a rule, all classes of equity other than common stock – regardless of name – represent some form of preferred stock since they have preference (priority) over common stock in terms of dividends and liquidation proceeds.

There are a number of varieties of preferred stock:

• Cumulative preferred stock – A form of preferred stock whose dividends, if passed, accumulate until they are paid out in full.  All passed dividends (arrearage) plus the current dividend must be paid to the current holders of cumulative preferred stock before dividends can be paid on other classes of equity.  Arrearage is the amount by which dividends on cumulative preferred stock are due but not yet paid.  Most preferred stock is cumulative.
• Noncumulative preferred – A class of preferred stock on which passed dividends do not accumulate and are not paid to shareholders at a later date.
• Participating preferred stock – A form of preferred stock common in continental Europe that, under specified conditions, pays an amount of the company’s distributable earnings in excess of the fixed minimum dividend, the amount fluctuating according to profits.  Owners of participating preferred stock do not participate in company profits beyond the fixed dividend until the company has paid:
  1. Dividends to holders of nonparticipating preferred stock;
  2. The basic dividend rate; and
  3. Matching basic dividends to common stockholders.
• Nonparticipating preferred stock – Preferred stock that pays only a fixed dividend and not the right to otherwise participate in the distribution of the company’s profits.  Nearly all preferred stock issued by US and UK companies is nonparticipating.