Definition: Preferred stock is a class of corporate shares that are separate from common stockand have specific rights that aren’t available to common shareholders. You can think of a preferred share as a premium or priority share that the company issues to senior investors. These shares come with special rights that give these senior investors preferred status over the common shareholders.
What Does Preferred Stock Mean?
The first right that preferred shareholders enjoy is the right to dividends receive dividends before common stock shareholders. Don’t get confused, however. This isn’t the right to receive a dividend. All shareholders can only receive a dividend when the board of directors declares one.
Shareholders can’t demand that the corporation pay a dividend. Preferred shareholders usually have the right to receive a dividend before common shareholders. This means that the preferred shareholders will be paid first and any dividends left over will go to the common shareholders.
Cumulative preferred shares have the right to be paid current and past years’ unpaid dividends before common stock shareholders are paid. If dividends are not declared in the current year, the cumulative shares record the unpaid dividends in an account called dividends in arrears.
When the board of directors does declare a dividend, it must pay the cumulative preferred shareholders all of the past years’ dividends in arrears and the current year’s dividend before common shareholders are paid anything. In other words, common stockholders might not receive a distribution depending on how much is saved up in arrears.
These extra benefits and rights are often required to spur investors’ interests because preferred shareholders typically don’t have the right to vote the same way that common stockholders do. You can think of purchasing a preferred share as a passive investment with no voting rights or control in how the company is run. It is simply there to collect a return on its investment.