Skip to content
All library documents

Preferred Stock Dividend Priority and Bankruptcy Recovery

Article Quant Q&A · Author: user5646514
Read the original

Summary

This discussion explains why Graham’s warning about preferred shares does not conflict with the claim that preferred shareholders rank ahead of common shareholders. It distinguishes dividend conditions during a company’s operations from the order of claims in bankruptcy.

Some preferred issues restrict payment of common dividends unless preferred dividends are also paid, though terms vary. The company may generally suspend preferred dividends if it also stops common dividends, subject to the security’s provisions. In bankruptcy, preferred holders rank ahead of common holders in claims on assets. The discussion cautions that creditors often absorb losses first and may take control, leaving little or no recovery for either class of shareholders. “Paid before” describes priority or a condition for paying common dividends, not necessarily when cash is paid. These are general explanations; the specific terms of an issue and the company’s financial condition determine the outcome.

Key ideas

  • Preferred stock may include terms that prohibit common dividends unless preferred dividends are paid.
  • A company may be able to suspend preferred dividends when it suspends common dividends, depending on the issue’s terms.
  • In bankruptcy, preferred shareholders rank ahead of common shareholders but behind creditors.
  • Creditor losses and control in bankruptcy can leave both preferred and common shareholders with no recovery.
  • Payment priority describes claims or conditions, not necessarily payment timing.

Tags

EquitiesFixed incomeRisk management
Full text
# Were preferred stock ever paid after common stock? -- Intelligent Investor question


# Were preferred stock ever paid after common stock? -- Intelligent Investor question












In the Intelligent Investor, Graham seems to be very much against buying preferred stock as an individual investor.

Graham:

> The typical preferred shareholder is dependent for his safety on the ability and desire of the company to pay dividends on its common stock. Once the common dividends are omitted, or even in danger, his own position becomes precarious, for the directors are under no obligation to continue paying him unless they also pay on the common. On the other hand, the typical preferred stock carries no share in the company’s profits beyond the fixed dividend rate. Thus the preferred holder lacks both the legal claim of the bondholder (or creditor) and the profit possibilities of a common shareholder (or partner).

I must be really needing some coffee, or does this actually contradict what we see on Investopedia?

Investopedia:

> Preference shares, more commonly referred to as preferred stock, are shares of a company’s stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, preferred stockholders are entitled to be paid from company assets before common stockholders.

Could you help me understand this? Thank you for reading thus far 🙏

## Answer by cpage (score 3)

https://quant.stackexchange.com/a/69213

There’s no contradiction. Graham is referencing the covenant that Preferred Shares often include that prevents companies from paying dividends on common stock unless they also pay the preferred dividend. The exact requirements can vary from preferred to preferred. It is often the case the company has no “requirement” to pay preferred holders if they are fine forgoing a common dividend.

Investopedia is referencing that Preferred stock recovers ahead of the common stock in a bankruptcy filing. While this is technically true, in practice the creditors (i.e. the debt) often are impaired in a bankruptcy so they seize control of the company (as the fulcrum security) leaving both the preferred and common shares with zero recovery.

The use of “paid…before” or “paid after” is in no way referring to the timing of payments. This is all about precedence. When we say the preferred dividend must be paid before the common dividend, this is shorthand for the company is required to pay the preferred dividend in order to pay the common dividend.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.