Definition: Participating preferred stock is preferred stock that shares dividends paid over a certain percentage with common stock. This percentage is stated on the preferred stock certificates.
What Does Participating Preferred Stock Mean?
Preferred shareholders are entitled to receive dividends before common stockholders. This is the trade off for preferred stockholders being denied ownership in the company. Normally, preferred stock is entitled to a percentage dividend before common shareholders.
If a larger dividend than the preferred percentage is issued, the rest of the dividend is given to the common stockholders. So if 2% preferred stock was outstanding and the company issued a 5% dividend, the preferred shareholders would receive the first 2% dividend and the common shareholders would receive the remaining 3% dividend.
Preferred stock issued with a participating option not only entitles the preferred shareholders to their initial dividend percentage; it also allows preferred shareholders to split the remaining dividend with the common shareholders.
Let’s go back to our earlier example. If the company had 2% participating preferred stock outstanding, the first 2% of the dividend would still go to the preferred shareholders. The remaining 3% would then be split between the common shareholders and the preferred shareholders.
As you can see, the participation option is a great option for preferred shareholders because they could double their dividend income. Participating preferred stock is rarely issued in the real world because most companies don’t want to upset their common stockholders by making them split dividends. Also, preferred shareholders rarely need this much motivation to buy stocks.