Arrearage refers to the amount of any past due obligation. In financial terminology, this includes unpaid interest on bonds or unpaid dividends on cumulative preferred stock. For companies, common dividend distributions are restricted if cumulative preferred dividends are in arrears.
What is Arrearage?
Arrearage encompasses any overdue financial obligation. This term is often used in contexts such as loans, leases, mortgages, and other types of debt instruments.
Arrearage in Investment
In investment terminology, arrearage specifically refers to:
- Interest on Bonds: When bond interest payments remain unpaid past their due date.
- Cumulative Preferred Stock Dividends: When dividends on cumulative preferred stock are unpaid. These unpaid dividends must be settled before any dividends can be distributed to common stockholders.
Special Considerations
Cumulative Preferred Stock
Cumulative preferred stock is a type of preferred stock where dividends accumulate if not paid in a given period. These unpaid dividends must be cleared in future periods before any dividends can be paid to common shareholders.
Example
Suppose a company issues cumulative preferred stock with an annual dividend of $5 per share and fails to pay this dividend for two consecutive years. If the company then wishes to declare dividends for common shares in the third year, it must first pay $10 per cumulative preferred share to cover the arrearage.
Historical Context
The concept of arrearage has been integral to financial markets since the proliferation of bonds and stocks as investment instruments. Historically, maintaining an awareness of arrearage helped ensure the fair treatment of preferred stockholders and bondholders.
Applicability in Finance
Arrearage can impact several areas in finance:
- Liquidity Assessment: Unpaid obligations can affect a firm’s liquidity and creditworthiness.
- Investment Decisions: Investors may use information about arrearage to assess risk and potential returns.
- Corporate Governance: Ensuring arrearage is managed affects shareholder relations and regulatory compliance.
Comparisons with Similar Terms
Default
While arrearage refers to overdue payments, default indicates a failure to meet financial obligations, possibly leading to more severe consequences like bankruptcy.
Accrued Expenses
Accrued expenses are financial obligations that have been incurred but not yet paid. Arrearage is a specific type of accrued expense, distinguished by being overdue.
FAQs
What is the difference between arrearage and default?
How does arrearage affect common stock dividends?
Can arrearage impact a company’s credit rating?
References
- Ross, S.A., Westerfield, R.W., & Jaffe, J. (2013). Corporate Finance. McGraw-Hill Education.
- Brigham, E.F., & Houston, J.F. (2015). Fundamentals of Financial Management. Cengage Learning.
Summary
Arrearage signifies overdue financial obligations, especially in areas of investment where it affects bond interest and cumulative preferred stock dividends. Recognizing and managing arrearage is crucial for maintaining corporate health and investor confidence. Understanding its implications helps in making informed investment choices and corporate decisions.
