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What is a Preferred Dividend?

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  • Written By: Geri Terzo
  • Edited By: C. Wilborn
  • Last Modified Date: 08 November 2016
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A preferred dividend is a distribution by a company to holders of its preferred stock. Preferred shareholders are a high priority to a company, and therefore receive dividends prior to common shareholders. Unlike common stock dividends, which are announced on a quarterly basis, preferred dividends are cumulative, which means payments are accrued over time whether the distribution is made quarterly or not. Distributions are typically paid quarterly or yearly in cash or stock as a reward to shareholders from a company's profits.

There are several benefits tied to being a preferred shareholder. A preferred dividend is a fixed amount, and the yield or return is often higher than for common-stock dividends, which are decided based on profitability. Participating preferred shareholders are a specific type of preferred shareholder. A company's board of directors may decide to reward participating preferred shareholders with an additional dividend on top of the fixed amount when profits are better than expected.

Preferred shareholders also face some uncertainties. A preferred dividend is not an obligation, and the decision to distribute payments is up to a company's board. The board may decide to interrupt distributions during times of economic crisis or if profitability is at stake. A company may also resume payments when the board sees fit. Some of the largest companies in the world have paid consecutive quarterly dividends for decades.

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A preferred dividend may also be deferred by a company. There are several benefits to this scenario, both for a company and its shareholders. For the company, it is a way to temporarily preserve cash.

Several scenarios might warrant a deferral. For instance, a company might be facing a temporary financial setback, but expects profits will recover in the near term. Economic conditions might have diminished to the point that it is only prudent to reserve cash. A company may opt to defer distributions to preferred shareholders, but remains on the hook for the cash. It may not resume any dividend payments to common shareholders until preferred dividends are paid.

While there are certain benefits reserved for preferred shareholders, including the routine dividend distributions, there are some drawbacks. Common shareholders are awarded voting rights at a company based on the number of shares held, a right that is not extended to preferred shareholders. Convertible preferred shares, another type of preferred stock, may be converted to common shares if an investor prefers. In the event of a corporate bankruptcy, both types of investors are at risk. Shareholders will receive a preferred dividend payout before any common shareholders are paid, but creditors and bondholders take priority over both.

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