Introduction
A non-cumulative preference share is a type of equity that grants its holders preferential rights to dividends over ordinary shareholders. However, unlike cumulative preference shares, if the company decides not to pay a dividend in any given year, those dividend rights do not carry over to future years.
Historical Context
The concept of preference shares dates back to the early 19th century, when companies began issuing stock with different rights attached to better attract different types of investors. Non-cumulative preference shares were designed to balance the interests of investors looking for stable income and the companies that might face fluctuating profits.
Types of Preference Shares
- Cumulative Preference Shares: Shareholders have the right to claim any unpaid dividends in future years.
- Non-Cumulative Preference Shares: Shareholders forfeit the right to unpaid dividends if they are not declared in a given year.
- Convertible Preference Shares: Can be converted into a predetermined number of ordinary shares.
- Redeemable Preference Shares: Can be bought back by the issuing company at a future date.
Key Events and Regulatory Aspects
- 1900s-1930s: Use of preference shares expanded as companies sought to attract capital without diluting control of common shareholders.
- 1930s-1940s: During economic downturns, many companies defaulted on cumulative dividends, prompting a higher issuance of non-cumulative shares.
- 2008 Financial Crisis: Companies preferred issuing non-cumulative preference shares to maintain financial flexibility.
Importance and Applicability
Importance
- Flexibility for Companies: Companies can decide not to pay dividends without the burden of accruing obligations.
- Risk Management: Investors assume a higher risk, which might translate into higher potential returns compared to cumulative preference shares.
Applicability
- Capital Structure: Used in structuring the capital to balance the need for regular income to investors and financial flexibility for the company.
- Dividend Policies: Influences the dividend payout policies of companies, especially during fluctuating business cycles.
Examples
- Financial Institutions: Often issue non-cumulative preference shares to meet regulatory capital requirements without accruing dividend liabilities.
- Startups: May offer these to attract investments while retaining control and flexibility over their finances.
Considerations
- Risk Factor: Higher risk due to the forfeiture of unpaid dividends.
- Dividend Preference: Preference in dividend payments over ordinary shareholders but lack of accumulation makes them less attractive to risk-averse investors.
- Market Perception: Issuance of such shares might signal financial instability or conservative dividend payout policies.
Related Terms
- Cumulative Preference Share: These shares carry the right to claim unpaid dividends in future periods.
- Ordinary Share: Common equity without preferential rights to dividends.
- Convertible Share: Can be converted into ordinary shares under certain conditions.
- Dividend: A payment made by a corporation to its shareholders.
Interesting Facts
- Investor Strategy: Some investors prefer non-cumulative preference shares as a short-term investment during periods of high profitability for companies.
- Preferred for Banks: Banking regulations sometimes favor non-cumulative preference shares to ensure banks maintain liquidity during financial crises.
Inspirational Stories
- Successful Turnarounds: Companies like General Motors issued non-cumulative preference shares post-restructuring to stabilize their financials while emerging from bankruptcy.
Famous Quotes
“Do not count your chickens before they are hatched.” — A reminder that expected future dividends are not guaranteed with non-cumulative preference shares.
FAQs
Q1: What happens if a company skips dividends on non-cumulative preference shares? A1: Shareholders cannot claim these dividends in the future; they are forfeited.
Q2: Are non-cumulative preference shares riskier than cumulative ones? A2: Yes, they are riskier as unpaid dividends are forfeited, which makes them less attractive to risk-averse investors.
References
- Brealey, R. A., Myers, S. C., & Allen, F. (2016). Principles of Corporate Finance.
- Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management.
- Dividend Policy Theories and Their Application in the Real World. Journal of Finance.
Summary
Non-cumulative preference shares offer an investment option that balances investor income preference with a company’s financial flexibility. While they present higher risk due to the forfeiture of unpaid dividends, they provide a strategic tool in structuring capital and dividend policies. Understanding their function and implications helps investors make informed decisions in diverse financial landscapes.
