FINRA Series 7Investment Information and Suitable RecommendationsEasy
XYZ Corporation has $6 cumulative preferred stock outstanding. The company suspended all preferred dividends for the past two years due to poor earnings. Before XYZ can resume paying dividends to common stockholders, what must occur?
- AThe preferred shareholders must formally vote to release the company from the arrearage
- BCommon shareholders must approve a resolution authorizing payment of the arrearage
- COnly the current year's preferred dividend must be declared and paid
- DAll dividends in arrears on the preferred stock must be paid in full to preferred shareholders
Show answer & explanationAnswer & explanation
Correct answer: D. All dividends in arrears on the preferred stock must be paid in full to preferred shareholders
Because the preferred stock is cumulative, any unpaid (skipped) dividends accumulate as arrears and must be paid in full before any dividend can be paid to common stockholders. This is the defining feature of cumulative preferred stock.
Why the other options are wrong
- A. Incorrect — preferred shareholders do not vote to waive arrears; payment is contractual.
- B. Incorrect — common shareholders have no authority over preferred dividend arrears.
- C. Incorrect — only paying the current year ignores the accumulated arrears.
Cumulative Preferred Stock
Preferred stock on which unpaid dividends accumulate as arrears and must be paid in full before any common dividend is paid.
- Missed dividends accumulate as arrears
- Arrears must be paid before common dividends
- Noncumulative preferred does not accumulate missed dividends
Memory trick: Cumulative = 'catches up' before common gets paid.