Background
Cumulative preference shares (also known as cumulative preferred stock) are a class of shares in a company that carry a fixed dividend and provide the holder priority over ordinary shareholders in terms of dividend payments. These shares are particularly important during financial downturns or in scenarios where a company does not have sufficient profits to declare dividends to all of its shareholders.
Historical Context
The concept of preference shares emerged in the early 20th century as companies sought ways to attract investment while offering more security in terms of dividends. Cumulative preference shares became a popular financial instrument because they promised consistent dividend payments even in times when a company’s earnings fluctuated or were insufficient to pay dividends to ordinary shareholders.
Definitions and Concepts
A cumulative preference share fundamentally offers two key benefits to holders:
- Priority in Dividend Payments: Dividends must be paid on these shares before any distribution to ordinary shareholders.
- Arrears Carry-Forward: If the company fails to pay dividends in any fiscal year, the unpaid dividends accumulate and must be settled in subsequent years before any dividends can be paid to ordinary shareholders.
Major Analytical Frameworks
Classical Economics
Classical economists would likely view cumulative preference shares as a means to attract a more risk-averse class of investors willing to accept fixed returns over variable profits.
Neoclassical Economics
Neoclassical analysis would focus on the utility derived by this lower-risk investment, emphasizing on how cumulative preference shares meet the needs of investors looking for guaranteed returns in uncertain markets.
Keynesian Economic
Keynesians might integrate cumulative preference shares into broader financial policies aimed at stabilizing an economy, where such shares can provide steady income streams for investors, potentially impacting their consumption patterns.
Marxian Economics
From a Marxian perspective, cumulative preference shares might be analyzed as a tool of capitalist mechanisms that ensure returns to wealthier, less risky investments, leading to reinforced financial hierarchies.
Institutional Economics
Institutionalists would be interested in the legal and corporate frameworks that make cumulative preference shares viable, emphasizing the standardized rights and protections they offer to investors.
Behavioral Economics
Behavioral economists might study how the promise of reliable dividends psychologically influences investor behavior, possibly making them more conservative and less likely to shift investments rapidly.
Post-Keynesian Economics
Post-Keynesians would view cumulative preference shares in terms of their impact on corporate financial strategies, potentially leading to less volatile business cycles.
Austrian Economics
Austrians would focus on individual choice and market freedom, perhaps arguing that cumulative preference shares create more diversified opportunities for investment, thereby fostering economic stability.
Development Economics
In developing economies, cumulative preference shares can be instrumental in attracting foreign and domestic investment into companies by offering secured but modest returns.
Monetarism
Monetarists might be less concerned with the specifics of cumulative preference shares but would acknowledge their role in impacting the broader money supply and investment strategies within an economy.
Comparative Analysis
When compared to ordinary shares:
- Dividends on cumulative preference shares are first claims: Arrears from previous non-paid dividends must be settled, unlike ordinary shares which may simply miss out on dividends in non-profitable years.
- Fixed vs. variable returns: Cumulative preference shares usually offer fixed dividend rates, whereas ordinary shares receive varying dividends based on profits.
Comparing to non-cumulative preference shares:
- Arrears feature: The primary distinguishing feature is that cumulative preference shares accumulate unpaid dividends to be disbursed in future profitable periods, non-cumulative shares do not.
Case Studies
Considerations of companies that have issued cumulative preference shares, such as preferred dividend structures during financial recessions or examining regulatory changes impacting these shares, can provide deeper insights into their practical applications and benefits.
Suggested Books for Further Studies
- “The Theory of Investment Value” by John Burr Williams
- “Finance and the Economics of Uncertainty” by Giorgio Szego
- “Principles of Corporate Finance” by Richard A. Brealey and Stewart C. Myers
Related Terms with Definitions
- Ordinary Share: A share where dividends are paid based on available profits and performance of the company, without priority over other types of shares.
- Dividend: A portion of a company’s earnings distributed to shareholders.
- Non-Cumulative Preference Share: A preference share that does not accumulate unpaid dividends from previous years.
