What is participating preferred stock, and how are dividends allocated between preferred and common shareholders?

Participating preferred stock is a special class of preferred that receives dividends in two stages: first, the stated preferred dividend, then a participation in additional dividends alongside common shareholders.

Types of Participation:

1. Fully participating — after both preferred and common receive the stated preferred rate, all remaining dividends are shared proportionally based on total par values
2. Partially participating — preferred participates in additional dividends up to a specified cap (e.g., an additional 3%)

Dividend Allocation — Fully Participating:

Step 1: Pay preferred shareholders their stated dividend

Step 2: Pay common shareholders an equivalent per-share rate

Step 3: Distribute remaining dividends proportionally based on par value

Worked Example — Lakewood Industries:

Capital structure:

• 10,000 shares of 6%, $100 par participating preferred stock
• 200,000 shares of $5 par common stock
• Total dividends declared: $250,000

Step 1: Preferred stated dividend

10,000 × $100 × 6% = $60,000

Step 2: Common matching rate

Common receives the same rate: 200,000 × $5 × 6% = $60,000

Step 3: Remaining dividends shared proportionally

Remaining = $250,000 − $60,000 − $60,000 = $130,000

Total par values:

• Preferred: 10,000 × $100 = $1,000,000
• Common: 200,000 × $5 = $1,000,000
• Total: $2,000,000

Preferred share of remainder = $130,000 × ($1,000,000 / $2,000,000) = $65,000

Common share of remainder = $130,000 × ($1,000,000 / $2,000,000) = $65,000

Total Allocation:

Per-share dividends:

• Preferred: $125,000 / 10,000 = $12.50/share
• Common: $125,000 / 200,000 = $0.625/share

Partially Participating Example:

If the preferred is participating up to an additional 2%:

• Step 1: Preferred gets $60,000 (6%)
• Step 2: Common gets $60,000
• Step 3: Preferred gets an additional 2% × $1,000,000 = $20,000 (capped)
• Step 4: Common gets ALL remaining = $250,000 − $60,000 − $60,000 − $20,000 = $110,000

Key Exam Points:

1. For basic EPS, subtract ALL preferred dividends (including the participating portion) from net income.
2. Non-participating preferred only receives the stated dividend — no sharing in excess.
3. Participating features make preferred stock more valuable and more equity-like.

Check our CFA Level I question bank for more dividend allocation problems.