Dividends Although a firm’s board of directors declares a dividend on its preferred

Dividends Although a firm’s board of directors declares a dividend on its preferred

stock, it is not a legal obligation. That is, if a firm does not pay the divi- dend, preferred shareholders cannot legally force payment. Nevertheless, almost all firms pay their specified preferred dividend. When dividends are paid, preferred dividends must be paid first; what remains may be paid as dividends to common shareholders. Most preferred share divi- dends are paid in cash, though a few preferred stock issues allow the firm issuing them to pay preferred dividends in cash or shares of stock.

Preferred Stock

Most preferred dividends are paid quarterly, though monthly, semi- annual, and annual dividends are possible. And preferred dividends may

be paid at either a fixed or floating rate per period. Fixed versus Adjustable Rate Dividends

Fixed dividends are expressed as either a percentage of the par value or

a fixed dollar amount per period. If you own a preferred stock with a $100 par value and an 8% annual dividend, you receive $8.00 in divi- dends per year. This dividend also could have been stated simply as $8.00 per share annually. Before 1982, all publicly issued preferred stock was fixed-rate preferred stock.

In May 1982, the first adjustable-rate preferred stock (ARPS) issue was sold in the public market. The dividend rate on an adjustable-rate preferred stock is typically fixed quarterly and based on a predeter- mined spread from the highest of three points on the Treasury yield curve. The predetermined spread is called the dividend reset spread. Most adjustable-rate preferred stock is perpetual, with a floor (i.e., a minimum rate) and a cap (i.e., a maximum or ceiling rate) imposed on the dividend rate of most issues. This maximum and minimum dividend rate feature is referred to as a collar. From the perspective of the issuer,

a collar’s maximum ensures that the costs of financing with preferred stock are limited; from the perspective of the investors, a collar’s mini- mum ensures that the return on the preferred stock has a lower limit.

The popularity of ARPS lost favor with investors when these securi- ties began to sell below their par value—because the dividend reset rate is determined at the time of issuance, not by market forces. In 1984, a new type of preferred stock, auction preferred stock, was designed to overcome this problem. The dividend rate on auction preferred stock is set periodically, as with adjustable-rate preferred stock, but it is estab- lished through an auction process. (More specifically, it is through a Dutch auction.) Participants in the auction consist of current holders and potential buyers. The dividend rate that participants are willing to accept reflects current market conditions.

Remarketed preferred stock is preferred stock where the dividend rate is determined periodically by a remarketing agent who resets the dividend rate so that any preferred stock can be tendered at par and be resold (remarketed) at the original offering price. Typically, an investor has the choice of dividend resets every seven days or every 49 days.

Since the mid-1980s, auction preferred stock and remarketed pre- ferred stock have become the dominant type of preferred stock issued.

FINANCING DECISIONS