Dividends in Arrears

Dividends in arrears are dividends on cumulative preferred stock that a corporation skipped in a prior period and that have since accumulated as an unpaid obligation, remaining outstanding until the corporation eventually catches up and pays them in full. Because the preferred stock is cumulative, these missed dividends do not simply disappear the way they would on non-cumulative preferred stock; they persist as a growing claim against future dividend payments.

Despite representing a real future obligation, dividends in arrears are generally not recorded as a formal liability on the balance sheet, since under ordinary dividend accounting no liability exists until a dividend is actually declared by the board, and a corporation facing financial difficulty may simply choose not to declare a dividend at all in a given period. Instead, dividends in arrears must be disclosed in the notes to the financial statements, both the total dollar amount and the per-share amount, so that readers, particularly potential buyers of the corporation's common stock, understand exactly how large the accumulated preferred claim has become.

A corporation with 10,000 shares of $100 par, 6% cumulative preferred stock has an annual dividend obligation of $60,000. If the corporation skips this dividend for two consecutive years before resuming payments, it has $120,000 of dividends in arrears, disclosed in the notes as $12 per preferred share. Before any dividend can be paid to common stockholders, the corporation must pay this full $120,000 arrears balance, plus the current year's own $60,000 preferred dividend, a combined $180,000 preferred claim that must be satisfied first.

For preferred stockholders, dividends in arrears represent real protection, since the cumulative feature guarantees that skipped dividends are not simply forfeited, only delayed. For common stockholders, a large and growing dividends-in-arrears balance is an important warning sign, since it means no common dividend can legally be paid until the entire preferred backlog, plus the current year's preferred dividend, has been cleared in full, which can mean common stockholders go without any dividend for an extended period even after the corporation's underlying financial performance has genuinely begun to recover.

A corporation clears its dividends in arrears only by formally declaring and paying the full backlog, typically once its financial position improves enough to support doing so; there is no shortcut or partial settlement that releases the common stockholders’ restriction early. Until that full catch-up payment is declared, the disclosed arrears balance simply continues to grow each period the preferred dividend is skipped, making the eventual cost of resuming dividends larger the longer a corporation goes without addressing it.

Investors valuing a company’s common stock treat a large dividends-in-arrears balance on outstanding preferred stock as an effective reduction in what common shareholders can expect to receive for some time to come, since the preferred backlog must be cleared first, which is why disclosed arrears figures are scrutinized closely by anyone evaluating whether a struggling company’s common stock is attractively priced.