The term participating preferred stock refers to securities containing a feature that allows shareholders to receive an additional dividend if certain conditions are met. This additional dividend is typically linked to the payment of common stock dividends. When preferred stock contains this feature, the securities can be fully-participating or partially participating.
Companies have the ability to attach a number of features or restrictions to the preferred stock they issue to the market. For example, preferred stock can be issued as cumulative, participating, convertible, and callable. These features can add to, or subtract from, the value the security provides investors.
It's uncommon for companies to issue participating preferred stock; however, this feature is sometimes used by companies as a poison pill defense. For example, the holders of participating preferred stock could be offered the opportunity to purchase common stock of the new company at an unusually low price; thereby thwarting a hostile takeover.
When offered, the holders of participating preferred stock are usually entitled to share in the dividends received by common stockholders. For example, the provision might state the holders of these securities are entitled to a dividend of $1.00 per share or the dividends per share paid to common stockholders, whichever is higher. The provision could also be tied to the rate of dividends. For example, the holders of these securities might be entitled to a dividend of 5.0% or the percentage paid to common stockholders, whichever is higher.
Company A has issued fully-participating preferred stock, paying a dividend of 5.0%, or $0.50 per share each quarter. Holders of these securities are entitled to their 5.0% dividend or the percentage paid to holders of common stock, whichever is higher.
Company A won a patent lawsuit in the most recent quarter, paying the holders of common stock a dividend equal to 7.0%. Since the preferred stock is fully participating, holders of these securities would be entitled to a payment of (7.0% / 5.0%) x $0.50, or $0.70 per share.