What is a Cumulative Dividend?
A cumulative dividend is a dividend, usually on preferred shares, that must be paid before any other dividends on any of the issuer's other securities. Preferred stock that does not carry a cumulative dividend is referred to as 'straight preferred.'
How Does a Cumulative Dividend Work?
Let's assume Company XYZ issues some preferred stock with a $1-per-share cumulative quarterly dividend. Company XYZ also has some common stock outstanding on which the company paid a $0.50-per-share dividend last quarter.
Now let's assume a recession has taken a toll on Company XYZ's cash flow, and the board has decided to suspend dividend payments. Because the preferred shares have a cumulative dividend, once Company XYZ decides to resume making dividend distributions, it must first 'catch up' on any missed dividends payments to the preferred shareholders (those outstanding the longest are paid first). Then it can resume making dividend payments to the holders of its common stock. It must do this even if it does not completely suspend the preferred dividends; reducing them creates a similar obligation.
Why Does a Cumulative Dividend Matter?
Preferred shares that have cumulative dividends often have slightly higher rates of return than straight preferred because cumulative preferred carries the added risk of possibly not receiving regularly scheduled dividend payments.