Cumulative & Callable Preferred

Features — the core trade-off

Preferred stock features affect how investors value the shares in the market.

🔑 Common finance relationship:

• Added benefits to investors generally mean a lower expected rate of return (compared with a similar security without the benefit).
• Added risks to investors generally mean a higher expected rate of return (compared with a similar security without the risk).

Keep that trade-off in mind while working through the features below.

Cumulative vs. straight

• The board of directors (BOD) must approve any dividend payments to preferred stockholders. Most of the time, dividends are paid as expected. However, if a company runs into financial trouble, the BOD can vote to skip or suspend dividends.
• Dividends on preferred stock are not a legal obligation. Even though skipping dividends can harm the issuer’s reputation and make it harder to raise money later, a company can’t pay dividends if it doesn’t have the cash.
• Preferred stock is “preferred” because it has priority over common stock for dividends. Before an issuer can pay any dividend to common stockholders, it must first pay all required dividends to preferred stockholders.

Whether preferred stock is cumulative or straight (non-cumulative) determines what happens to skipped dividends:

Worked example — cumulative vs. straight

ABC Company $100 par, 5% preferred stock

2023 - ABC Co. skips their dividend completely 2024 - ABC Co. skips their dividend completely 2025 - ABC Co. pays 3% of their 5% dividend

If ABC Co. wanted to make a payment to common stockholders in 2026, here’s what the required preferred dividends would look like under each type.

Cumulative The company must make up past skipped dividends and pay 2026’s dividend to preferred stockholders before it can pay any dividend to common stockholders. Required dividend payments 2023: must make up the 5% missed 2024: must make up the 5% missed 2025: must make up the 2% missed 2026: must pay 5% before common stock dividend The company must make a payout total of 17% ($17) to preferred stockholders

Straight (non-cumulative) The company is not required to make up past skipped dividends. Only 2026’s dividend to preferred stockholders must be paid before any dividend can be paid to common stockholders. Required dividend payments: 2023: will not make up the 5% missed 2024: will not make up the 5% missed 2025: will not make up the 2% missed 2026: must pay 5% before the common stock dividend The company must make a payout total of 5% ($5) to preferred stockholders

Cumulative preferred stock is more beneficial to investors when dividends are skipped.

In this example, the difference is a $17 per share payout versus a $5 per share payout. With 100 shares, that’s a $1,200 difference ($1,700 vs. $500).

Because cumulative preferred stock offers more protection to investors, issuers can typically sell it with lower dividend rates than straight preferred stock.

Participating

• If preferred stock is participating, it can receive dividends above the stated dividend rate.
• For example, if you own a $100 par, 5% preferred stock, you’d expect to receive $5 per year per share (assuming the BOD declares the dividend).
• If the preferred stock is participating, you could receive more than $5 per year in a strong year. When the issuer has a particularly profitable year, it may pay a larger dividend to participating preferred stockholders.

Participating preferred stock is beneficial to the stockholder, so it tends to:

• sell for higher prices in the market (higher demand)
• trade at lower yields (because higher prices imply lower yields)
• be issued with lower stated dividend rates than non-participating preferred stock

Callable

• When preferred stock is callable, the issuer can “take it back” by paying stockholders the par (face) value. A call feature allows the issuer to end the investment.
• Callable securities are typically callable at par.
• For example, assume you own a $100 par, 5% callable preferred stock:
  • If the issuer calls your preferred stock, it pays you $100 per share.
  • After the call, the shares are redeemed and you no longer receive dividend payments.
• This matters because preferred stock has no maturity date. Without a call feature, the issuer is essentially committing to pay dividends indefinitely (as long as dividends are declared).

Definitions

Why issuers call

Issuers typically call preferred stock for one of two reasons:

1. The issuer may choose to stop future dividend payments if it has the funds to do so (similar to paying off a loan early).
2. More commonly, the issuer calls the shares to refinance.

Sidenote — Refinancing

• You’ve probably heard the term “refinance” in the context of home mortgages. Assume you have a 30-year, 5% mortgage. When you bought your house, the interest rate you received was largely based on market interest rates. Assuming you had acceptable credit, many buyers at that time were likely getting similar 5% mortgages.
• Interest rates play a major role in real estate because interest can add up to a significant amount of money over time (sometimes more than the cost of the home itself).
• If interest rates rise to 8% after you get your loan, your 5% mortgage looks attractive. Your monthly payment would have been higher if you had waited.
• If interest rates fall, you may consider refinancing. For example, if rates drop from 5% to 3%, it can be appealing to pay off the old, higher-rate mortgage and replace it with a new, lower-rate mortgage. Refinancing can involve upfront costs and paperwork, but it may save substantial money over time.
• To summarize, refinancing replaces an older, more expensive obligation with a new, less expensive one. People, companies, and governments refinance when interest rates fall.

Calling to refinance

• When preferred stock is originally issued, its dividend rate is based on current market interest rates. If you purchased a $100 par, 5% preferred stock, market interest rates were likely close to 5% at the time.
• If interest rates fall to 3%, the issuer has a strong incentive to refinance its preferred stock. A common approach is:
  1. The issuer sells new preferred shares with a dividend rate aligned with current rates (3%).
  2. The issuer uses the proceeds to call the older $100 par, 5% callable preferred stock.
• As a 5% preferred stockholder, this is unfavorable. You lose a higher-dividend investment, and if you reinvest the call proceeds, you’ll likely find similar preferred shares yielding around 3%.

Call protection and call premium

To make callable preferred stock more marketable, issuers often provide call protection.

Feature comparison at a glance

Key points

Cumulative preferred stock

• Issuer must eventually pay skipped dividends
• Beneficial feature for investors
• Lower rates of return (vs. straight)

Straight (non-cumulative) preferred stock

• Issuer does not pay skipped payments
• Beneficial feature for the issuer
• Higher rates of return (vs. cumulative)

Participating preferred stock

• Eligible to receive more than the stated dividend rate
• Issuers pay more in profitable years
• Beneficial feature for the investor
• Lower dividend rates (vs. non-participating shares)
• Trades at higher prices and lower yields

Call features

• Allows issuer to end an investment by paying back its par value
• Calls typically occur when interest rates fall
• Beneficial for the issuer
• Sold with higher dividend rates (vs. non-callable)
• Lower prices & higher yields
• Used by issuers to refinance

Call protection

• Number of years before security can be called

Call premium

• Amount above par required to call shares

Sources

Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.