Definition

participating dividend

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What is participating dividend?

Participating dividend gives the receiver a right to participate in the profits of a company. It gives a right to get a percentage of a company's profits over the fixed dividend payment. Unlike a cash dividend, it is not just a percentage of the nominal value of the shares held. A participating dividend is received by holders of a participating preferred stock of a company. They offer earnings and liquidation rights to the beneficiaries. These rights make participating dividends a lucrative return on investment.

Summary
  • Participating dividends give a right to holders to obtain a percentage of the company's profits above the fixed rate of dividend.
  • Participating preferred dividends may be paid by companies on an annual, semi-annual, or quarterly basis.
  • A participating dividend has 'downside protection' and 'upside benefits'.

Frequently Asked Questions (FAQ)

How do you calculate participating dividends?

On a participating preferred dividend, companies may pay dividends annually, semi-annually, or quarterly. The receivers of participating dividends are entitled to receive a portion of retained earnings in addition to the fixed dividend payment.

Determining fixed component-

To compute the fixed dividend on a participating preferred stock, first, the rate of dividend needs to be determined. The rate is often given in the prospectus for preferred stocks issued. For example, consider that Melodius Limited has declared a 4% return on participating preferred stocks. So, the fixed component of the dividend will be at 4%.

Next, we will determine the par value of participating preferred stocks. The par value is also given in the prospectus. For example, take the par value of Melodius Limited's participating preferred stock as AU$100.

Now, we can multiply the dividend rate by the par value of the preferred stock. So, Melodius Limited will be AU$10 x .04 = AU$0.4, which means 40 cents is the dividend payment per share of participating preferred stock.

We can multiply the dividend payment per share by the number of participating preferred shares issued by Melodius Limited. For example, the number of shares issued is 1,000,000 participating preferred shares. Then, the total participating preferred dividend paid by Melodius limited will be 1,000,000 x AU$0.4 = AU$400,000.

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Next, we determine the variable component-

We will take the total amount of retained earnings that Melodius limited plans to pay out as dividends. Let us consider that it plans to pay out AU$600,000 of retained earnings as participating dividends. So, then reduce the total participating preferred dividend payment from total retained earnings Melodius plans to payout. Here it will be, AU$900,000 - AU$400,000 = AU$500,000. Dividends paid to participating preferred shareholders are now deducted in the same way as dividends paid to common stockholders. Here we assume dividend payment on preferred and common stock is the same. So, we get, AU$500,000 - AU$400,000 = AU$100,000.

Now suppose, Melodius has issued 1,000,000 common shares. So, when we add the total amount of common shares to participating preferred shares issued by Melodius limited, we get 1,000,000 + 1,000,000 = 2,000,000 shares in total.

Next, we divide the remaining balance of retained earnings AU$500,000 by the total outstanding shares. Then, we get AU$500,000 / 2,000,000 = AU$0.25 which is 25 cents per share.

Thus for, Total dividend per participating preferred share-

We can add this to the preferred dividend paid per share, which is AU$ 0.4 or 40 cents per share. Thus, the total dividend paid per participating preferred share will be AU$0.4 + AU$0.25 = AU$ 0.65 or 65 cents per share.

What are participating preferred stocks?  

A participating preferred stock is a type of preference share and is treated on priority over common shares. Usually, the amount of dividend paid on the preference shares is based on the nominal value of these shares. However, in the case of participating preferred stocks, the dividends are based on profits earned. So just like their name, these shares participate in the profits. Therefore, such dividends are participating dividends.

At the time of liquidation, participating preferred shareholders may also have the right to receive back the stock's purchasing price along with a pro-rata share of any remaining liquidation proceeds.

Another example of participating dividends

For example, Orange Corp. issues preferred shares at a 15% dividend rate having a nominal value of $500 per share. Each preferential share is thus entitled to get dividends of $75 in the ongoing year. Now, Orange Corp. does well, and it offers an $80 per share common stock dividend. A non-participating preferred stock would thus receive only a prefixed $75 dividend per share, which is contractually agreed. However, a participating preferred stock is entitled to a participating dividend. Thus, it would 'participate' with common shares to obtain up to an extra $5 per share dividend, based on excess earnings and earnings participation provision.

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What are the benefits of participating dividends?  

The benefits to investors from participating dividends accrue from investing in participating preferred stocks. Few of these are-

  • These dividends give a higher rate of return compared to only cash dividends on common stock.
  • Investors will get the fixed dividend component even when earnings are low, or the company turns loss-making.
  • It gives a chance of participation in profits and higher returns in exceptionally well years.
  • A participating dividend has 'downside protection' and 'upside benefits'.
  • Shareholders entitled to participating dividends are next in line after debt holders in case of liquidation.
  • Beneficiaries of participating dividends can also claim any leftover surplus of liquidation expenses.
  • In liquidation, receivers of participating dividends get priority since they are a type of preferential shareholders.

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