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I am trying to understand preferred stocks. For cumulative preferred stocks, if any preferred dividend payments have been missed, the dividends owed must be paid out to the preferred stockholder first before the common stockholders can receive any dividends.

However, for non-cumulative preferred stocks, the issuer does not owe any missed dividend payments. Can the issuers of non-cumulative preferred stock simply refuse to pay dividends at any time? What incentivizes them to pay preferred dividends now when they aren't required to pay the dividends they miss?

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  • By the time a preferred stock's dividend is in question, you've long since overstayed your welcome. You should have left a long time ago.
    – Bob Baerker
    Sep 22, 2020 at 17:55

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The thing that motivates 'a company' (meaning, as a reminder, the Board of Directors voted in by the majority of voting shareholders) to pay dividends to non-cumulative preferred shareholders (which are often non-voting), is that preferred shares get preference in the order of dividends being paid out.

If I own 100% of the voting common shares of my private company, and you own non-voting non-cumulative preferred shares in that same company, I can't pay myself dividends until you get yours. Your preferred shares may have a clause stating what your owed annual amount is, even if it is not cumulative year over year. So if you own 100,000 shares with a stated dividend of $1, I can't pay myself a penny of dividends as a common shareholder, until in that same year I pay you your owed $100,000.

There are also typically jurisdictional laws that protect minority shareholders from mismanagement by majority shareholders, such that if you tried to do something like liquidate the company without paying me my owed dividends, I might be able to sue for payment. In reality however, non-cumulative preferred shares do have a limited value because if the example company above earns $1M a year, and you expect to effectively get 10% of its annual earnings through your dividends, I could simply not pay dividends for 5 years, then pay you $100k and pay myself the remaining $4.9M.

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  • The short answer is that the corporation elects not to pay dividends, owners of non-cumulative preferred shares have no claim to missed dividends, even if the company resumes paying dividends at a later date.
    – Bob Baerker
    Sep 22, 2020 at 16:50
  • @BobBaerker Agreed - and what incentivizes the voting common shareholders to pay dividends to non-cumulative preferred shareholders, is that otherwise they can't get dividends in that year. The risk that this could allow gamesmanship like what I hypothesized above, would not be considered abuse of corporate regulations in any jurisdiction I'm aware of, it is simply a sign of the reduced value of non-cumulative preferred shares.
    – Grade 'Eh' Bacon
    Sep 22, 2020 at 16:56
  • This sounds really risky for the non-cumulative preferred stock investor. Valuation must be so difficult.
    – Flux
    Sep 23, 2020 at 1:16
  • @Flux Quite often these shares are issued for reasons other-than general public issuance and trading. For example, these shares may have votes attached, and could be issued at the time of a parent broadening company ownership to their children, crystallizing their own value receivable without harming company cash flow, maintaining voting control, and passing future value growth to the next generation. I don't believe it's common for these to simply be issued non-voting, non-cumulative, and on the public market. To buy that, an investor would need a higher return than what a bond would pay.
    – Grade 'Eh' Bacon
    Sep 23, 2020 at 1:56
  • Of course, after issuance for whatever particular reason made sense at the time, the shares may float around in near perpetuity [and thus you may see some shares like this available for public trading now and again], particularly if there is neither a recall nor redemption clause.
    – Grade 'Eh' Bacon
    Sep 23, 2020 at 1:58

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