Participating preferred stock is a hybrid of the traditional preferred stock and common stock classes of shares. Participating preferred stock gives a shareholder the rights associated with both common shares and preferred shares. Preferred shareholders are usually entitled to a fixed dividend that is paid before any dividends are distributed to common shareholders. Participating preferred stock offers this same dividend preference to the holder, plus additional features.

The main additional feature of participating preferred stock is that holders are entitled to receive an additional dividend based on the same amounts paid to common shareholders. This means that if a company pays a dividend of $1 per common share, holders of one participating preferred share would also be entitled to receive the same $1 per share. Any additional or higher dividends than this are on top of the fixed preferred dividend, allowing the holder to really increase their yield.

The purpose of these shares is to make the preferred stockholders equal with the common stockholders in terms of returns. Preempting takeover attempts is another reason why a company would issue participating preferred shares. This happens when a company wishes to issue stock that counteracts a hostile takeover bid and entices existing shareholders to hold on to their shares. This tactic of issuing additional shares to existing shareholders is known as a poison pill strategy and can be beneficial when used in the correct manner.

While there are advantages, such as providing additional protection to shareholders, participating preferred stock also carries the potential of diluting the common stock and reducing the overall value of the company’s shares, since more securities are issued and distributed which decreases the current share price.

Overall, participating preferred stock is a special class of preferred stock that offers some added benefits to shareholders compared to standard preferred stock. The primary benefit is that holders of participating preferred stock are entitled to receive an additional dividend based on the same amount paid to common shareholders. This can be a great way to increase a shareholder’s yield, but it can also be a diluting factor when too much is issued. As such, it is important to carefully consider all the pros and cons before deciding if participating preferred stock is right for your situation.