The only type of preferred stock that has the potential for dividends in arrears is cumulative preferred stock. Having dividends in arrears is not positive for investors holding the shares. The good news is that the cumulative preferred investors are first in line if the company decides to make dividend payments.
Preferred shares have priority over common shares for dividend payments. A company cannot pay common share dividends unless the preferred shares are also paid. Most preferred share issues pay a fixed dividend, making this type of share a steady income source for investors. In the ranking of a company's payment obligations, preferred stock is senior to common stock but junior to interest payments on bonds.
If a company does not pay scheduled dividends on regular preferred shares, it can restart paying the dividends at the regular rate at any time and also pay common stock dividends. Skipped dividends on cumulative preferred shares are said to be in arrears, and all of the arrears dividend amounts must be paid to the cumulative preferred shareholders before any dividends can be paid to common shareholders. Investors holding cumulative preferred stock which is in arrears have the expectation that the missed dividends will be made up when the company is again able to make distributions.
Not in Default
A company is not in default if it misses a preferred dividend payment. Not paying bond interest is a default, but dividend payments, either preferred or common, is up to the company management. Preferred shares protect investors by making sure preferred dividends are paid if the company wants to pay common dividends, as well. Cumulative preferred shares give stronger rights, forcing the company to catch up on missed dividends before paying a common dividend.
Sign of Trouble
Even though a cumulative feature is a benefit to investors, dividends in arrears is as a possible sign that the company is in financial trouble. There is no guarantee that the arrears amounts will ever be paid. Preferred shares that go into arrears on the dividend payments warrant a close look at the company's overall financial situation.