The primary difference between cumulative and non-cumulative preference shares arises from how both handle unpaid dividends. Here’s a quick break-down of the cumulative vs. non-cumulative preference shares debate:
Accumulation of unpaid dividends
As mentioned earlier, cumulative preference shares allow for the accumulation of unpaid dividends. In other words, if the company misses on dividend payments due to any reason, this dividend income is carried forward to be paid at a later date. Unpaid dividends cannot be accumulated if the investor owns non-cumulative preference shares. In short, missed dividend income cannot be pooled and collected at a future time.
Rights of shareholders
Cumulative preference shareholders have a definite right over any and all unpaid dividends. They can exercise this right to collect a cumulative payout in the future when the company is ready to make such payments. In other words, the company cannot sidestep its responsibility to pay these accumulated dividends. However, non-cumulative preference shareholders are not entitled to a claim or right over unpaid dividends.
Risks involved
The risk quotient between owning cumulative and non-cumulative preference shares also varies. Cumulative shares are less risky than non-cumulative ones because they come with the promise of future payment. Non-cumulative preference shareholders face a higher risk because once a dividend is missed, they cannot claim it in the future. This makes non-cumulative shares less appealing to low-risk investors.
Dividend stability
Unlike common shares, where dividend payout is based on the performance of the company, preference shares carry a fixed dividend mandate. Despite this, the income stability offered by cumulative and non-cumulative preference shares differs greatly. Cumulative preference shares offer relatively steadier dividend income inflows with the guarantee of future payments if any dividend is missed. In other words, cumulative shares ensure payment security, even if it is at a later date. However, non-cumulative shares cannot accumulate dividends, making dividend income a little unpredictable.
Treatment of missed dividends
Cumulative preference shares treat missed dividends as future payments. All missed dividends are accumulated and will be collected in the future when the company resumes payment. Non-cumulative preference shares treat missed dividends as lost. They do not offer a guarantee of future compensation.