Question: Dagwood Inc.

recently noted that its 4% preferred stock and 4%

participating preferred stock, which are both cumulative, have priority as to
dividends up to 4% of their par value. Its participating preferred stock participates
equally with the common stock in any dividends in excess of 4%. What is meant
by the term participating? Cumulative?
Answer
Dagwood Inc. has a fully participating preferred stock in this case.
Step-by-Step Solution
Step 1: Meaning of Preferred Stock
Preferred stock is a type of equity investment that has both equity and debt
characteristics and has a higher ranking than common stock.
A fixed liquidation value (or par value) may or may not be connected with preferred
stock.
Step 2: Meaning of Participating
Security holders who do not participate in the income distribution have the right to only
receive the stipulated fixed income.
In the case of a partly participating security, it means that, in addition to the fixed
dividend payout, the security may also benefit from dividends that the ordinary stock
receives up to a specific amount or rate.
Step 3: Meaning of cumulative
Dividends that are not paid in a given year must be restored in the following year before
earnings can be distributed to individual investors.
An arrears dividend represents any dividends that have not been paid on
cumulative preferred shares. Dividend arrears are not a burden unless the board of
directors declares them.