What is Participating Preferred Stock?

Participating Preferred Stock

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Participating Preferred Stock

Participating Preferred Stock is a type of preferred stock that gives the holder the right to receive dividends equal to the generally specified rate of preferred dividends plus an additional dividend based on some predetermined condition.

The most common condition is that the participating preferred shareholders will receive additional dividends if the dividends paid to the common shareholders exceed a certain amount.

In addition to having a claim on dividends, participating preferred stock also typically carries a provision that in the event of the company’s liquidation, the holder has the right to claim both the purchase price and the unpaid dividends before the common stockholders receive anything.

For example, suppose a company declares dividends of $2.00 per share. The terms of a participating preferred stock might state that the preferred shareholders are entitled to a dividend of $1.00 per share, plus an additional amount if the dividends paid to common shareholders exceed $1.00 per share.

It’s worth noting that this type of stock can be beneficial to the investors as it gives them the possibility of earning more than the stated dividend, but it can be expensive for the company as it might have to pay more in dividends than it had initially anticipated. Because of these potential drawbacks, participating preferred stock is not as common as non-participating preferred stock.

Example of Participating Preferred Stock

Suppose a company, XYZ Corp., issues participating preferred stock with a face value of $100 per share, an annual dividend rate of 6%, and a participation feature of 50% of the dividends paid to common stockholders that exceed the $6.00 per share dividend on the preferred stock.

In a particular year, XYZ Corp. has done very well and declares dividends of $15 per share for common stockholders.

First, preferred stockholders would receive their stated dividend of $6 per share ($100 * 6%).

Next, we calculate the excess dividends for common stockholders. This would be $15 – $6 = $9.

As the preferred shares have a 50% participation rate, preferred shareholders will also receive 50% of this excess, which amounts to $4.50 per share ($9 * 50%).

So, in total, preferred shareholders would receive $10.50 per share ($6 + $4.50) for that year, thanks to the participation feature of their preferred stock.

Please note that the exact terms of the participation feature can vary greatly, and the example I provided is a simplified scenario. Always carefully review the terms of a specific security to understand how it works.

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