Cumulative Perpetual Preferred Stock: Definition, Example, and FAQs
Cumulative perpetual preferred stock is a type of preferred stock that combines two distinct features: the promise of dividends that accumulate if not paid, and no fixed maturity date. Belonging to the broader category of equity financing, this security offers investors a blend of characteristics typically found in both debt and equity instruments. Holders of cumulative perpetual preferred stock are entitled to receive all missed dividends from prior periods before any dividends can be paid to common stock holders. This cumulative feature provides a greater degree of income security compared to non-cumulative preferred stock, while its perpetual nature means the issuer is not obligated to redeem the shares at a specific date.
History and Origin
The concept of preferred stock emerged in the United States during the mid-19th century, primarily as a tool for corporations, especially railroads, to raise capital7, 8. Early forms of preferred stock were designed to provide investors with a more stable income stream than common equity, often with a priority claim on company assets in the event of liquidation. Over time, various features were introduced to preferred shares, including the cumulative and perpetual characteristics. The use of cumulative perpetual preferred stock gained particular prominence in certain financial contexts. For instance, during the financial crisis of 2008, the U.S. Treasury, under the Emergency Economic Stabilization Act, specifically issued guidance allowing bank holding companies to count newly issued "Senior Perpetual Preferred Stock" with cumulative dividends as Tier 1 capital, highlighting its role in bolstering financial stability during periods of market stress.6
Key Takeaways
- Cumulative perpetual preferred stock mandates that any missed dividend payments accumulate as an arrearage and must be paid before common shareholders receive any dividends.
- The "perpetual" feature means the stock has no maturity date, obligating the issuer to pay dividends indefinitely unless the stock is called or the company is liquidated.
- These shares typically offer fixed dividend rates, making them attractive to investors seeking predictable income.
- Cumulative perpetual preferred stock generally ranks higher than common stock in terms of dividend payments and asset claims during bankruptcy or liquidation.
- Unlike common stock, cumulative perpetual preferred stock usually carries no voting rights.
Interpreting Cumulative Perpetual Preferred Stock
Interpreting cumulative perpetual preferred stock involves understanding its dual nature as both an equity and fixed-income security. The "cumulative" aspect provides a layer of protection for investors: if a company faces financial distress and cannot pay its preferred dividends, these unpaid amounts accrue. The company cannot distribute dividends to its common shareholders until all such accumulated dividends on the cumulative preferred stock are settled. This feature can signal to potential investors a greater commitment from the issuer to maintain dividend payments, even if temporarily suspended.
The "perpetual" characteristic means that the stock theoretically exists forever, similar to a bond with no maturity. For investors, this implies a continuous stream of fixed dividends, provided the company remains solvent and declares the dividends. From the issuer's perspective, it represents permanent capital that does not require repayment, making it a valuable component of the capital structure. However, without a maturity date, investors seeking to recover their principal must sell their shares in the secondary market.
Hypothetical Example
Consider XYZ Corporation, which has issued 100,000 shares of 5% cumulative perpetual preferred stock with a par value of $100 per share. This means preferred shareholders are entitled to an annual dividend of $5 per share ($100 par value * 5%).
In Year 1, XYZ Corporation performs well and pays the full $5 per share dividend to its preferred shareholders.
In Year 2, due to unexpected market conditions, XYZ Corporation's board of directors decides not to declare any dividends to conserve cash. Since the preferred stock is cumulative, the $5 per share dividend for Year 2 is not lost; it accumulates. The preferred shareholders now have $5 per share in arrearage.
In Year 3, XYZ Corporation's financial situation improves significantly. Before the company can pay any dividends to its common stockholders, it must first pay the accumulated dividends to the cumulative perpetual preferred shareholders. This means each preferred shareholder will receive $10 per share: the $5 from Year 2's arrearage plus the current $5 dividend for Year 3. Only after these $10 per share payments are made can XYZ Corporation consider paying any dividends to its common shareholders. This example illustrates how the cumulative feature protects the preferred shareholders' right to receive all promised dividends.
Practical Applications
Cumulative perpetual preferred stock serves several practical applications in corporate finance and investment strategies. For corporations, it offers an avenue for equity financing that avoids diluting the voting power of existing common shareholders, as preferred shares typically do not carry voting rights. This can be particularly appealing for companies needing capital without relinquishing control. Additionally, since the stock has no maturity date, it provides a stable, permanent component to the company's capital structure without the mandatory repayment obligations of debt. Companies also use preferred stock to bolster their regulatory capital, especially in the financial sector. For example, Berkshire Hathaway's financial reports indicate its ownership of non-voting cumulative perpetual preferred stock of Occidental Petroleum, highlighting its use as a significant investment for large, sophisticated entities.5
From an investor's perspective, cumulative perpetual preferred stock is often favored for its predictable fixed dividend payments, which can be attractive for income-focused portfolios. The cumulative feature provides a measure of safety, ensuring that missed dividends are eventually paid. These characteristics can make them an appealing option for investors seeking higher yields than traditional bonds without taking on the full volatility or risk associated with common stock. For instance, an SEC filing from MODIV INC. details the issuance of 7.375% Series A Cumulative Redeemable Perpetual Preferred Stock, outlining the terms of its cumulative dividends and lack of a maturity date, demonstrating its role in real-world capital raising.4
Limitations and Criticisms
Despite its advantages, cumulative perpetual preferred stock comes with certain limitations and criticisms. A primary drawback for investors is the limited potential for capital appreciation. Unlike common stock, which can see significant price increases with company growth, the value of preferred stock tends to remain relatively stable, tied more to interest rate fluctuations than to the company's earnings growth. This means preferred shareholders generally do not participate in the substantial upside that common shareholders might experience if the company thrives.3
Another significant concern is interest rate risk. Because preferred stock typically pays a fixed dividend, its market price generally falls when prevailing interest rates rise, as newer issues will offer more attractive yields. Conversely, if interest rates decline, the issuing company may exercise a "call" feature, redeeming the preferred shares at a predetermined price. This leaves investors with their capital returned at a time when reinvesting at a comparable yield is challenging.2 Furthermore, while preferred stock has seniority over common stock in liquidation, it remains subordinate to all forms of debt. In a severe bankruptcy, after creditors and bondholders are paid, there may be little or nothing left for preferred shareholders, let alone common shareholders. Finally, the absence of voting rights for cumulative perpetual preferred stock holders means they have little to no say in corporate governance or strategic decisions, which can be a significant limitation for investors seeking influence over the companies they invest in.1
Cumulative Perpetual Preferred Stock vs. Non-cumulative Preferred Stock
The key distinction between cumulative perpetual preferred stock and non-cumulative preferred stock lies in the treatment of missed dividend payments. With cumulative preferred stock, if a company's board of directors chooses to suspend dividend payments, those unpaid dividends accrue. This accumulation, known as arrearage, must be fully paid to cumulative preferred shareholders before any dividends can be distributed to common shareholders. This feature offers a higher degree of security for income-seeking investors, as their right to receive all promised dividends is preserved, even if delayed.
In contrast, non-cumulative preferred stock does not carry this right of accumulation. If the company fails to pay a dividend on non-cumulative preferred shares, that payment is simply forgone. The company is not obligated to make up for the missed dividend in the future, and it can resume paying dividends to common shareholders in subsequent periods without first settling any past missed preferred dividends. This characteristic makes non-cumulative preferred stock inherently riskier for investors relying on consistent dividend income, as their potential for receiving payouts is entirely dependent on the company's ability and willingness to pay in each specific period. Both types can be perpetual, meaning they have no maturity date, but the cumulative feature is the differentiating factor regarding dividend security.
FAQs
What does "perpetual" mean in cumulative perpetual preferred stock?
"Perpetual" means that the stock has no set maturity date. Unlike bonds or some other types of preferred stock, the issuer is not obligated to redeem the shares or return the initial capital to investors at a specific future date. This implies that the stock will continue to pay dividends indefinitely, as long as the company is operational and declares them.
Do cumulative perpetual preferred stock holders have voting rights?
Typically, no. Most cumulative perpetual preferred stock issues do not grant voting rights to their shareholders. This is a common characteristic that differentiates them from common stock, allowing companies to raise equity financing without diluting the control of existing common stockholders.
Are dividends on cumulative perpetual preferred stock guaranteed?
While the term "cumulative" implies a strong right to receive dividends, they are not strictly guaranteed in the same way that bond interest payments are. Dividends on preferred stock must be declared by the company's board of directors. If a company faces severe financial distress or bankruptcy, it may suspend preferred dividend payments. However, the "cumulative" feature ensures that any skipped payments accrue as an arrearage and must be paid before common shareholders can receive any dividends.