This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
Scrip dividends are those which are issued in the form of promises to pay on the part of the corporation. These promises may or may not bear interest. They usually mature at some definite date, but may be purely indefinite I. O. U.'s, redeemable at the option of the corporation or redeemable within a certain limit of time. They are intended usually to meet the situation which has been briefly described above - that of a corporation which has made a good showing of profits during a given period, but is not in sufficiently strong financial position to part with cash. Payment of dividends in scrip is sometimes voted in order to avoid spoiling a dividend record that would otherwise be unbroken or as a temporary expedient to keep up dividends on preferred stock. After the first West-inghouse reorganization in 1891, the first dividend of 1 3/4% on the preferred stock was issued in scrip, so as not to reduce the working capital immediately. In October, 1914, the Cambria Steel Company desired to keep up its regular 5% dividends, but, on account of the European War, the directors did not think it wise to pay out in cash the $562,500 required. On account of the dull state of trade, inventories were larger than usual, and available cash resources were smaller than usual. The directors solved the difficulty by issuing a scrip dividend bearing 5% interest. In 1910 the Crucible Steel Company of America took care of a portion of the accumulated dividends on its preferred shares by paying 10% on these shares in the form of scrip bearing 3% interest.
In 1881 Henry Villard after a considerable struggle obtained control of the Northern Pacific Railroad. In the course of his fight for control he had advocated the payment of dividends on the company's preferred stock, and in the first annual report after his election as president it was stated that the surplus earnings since 1875, amounting to $4,667,490, had been used for construction and were properly due to the preferred stockholders. On the strength of his statement, the directors declared a dividend to the preferred stockholders of 11%, which was not paid in cash but in the form of 5-year 6% obligations of the company redeemable after one year at the option of the company. When this scrip fell due in 1887, the company was in no condition to pay it in cash. It therefore imposed on its property a third mortgage amounting to $12,000,000, over $3,000,000 of which was used to meet the maturing dividend scrip.*
The payment of accumulated dividends on preferred shares has been, in a number of cases, taken care of in this manner. The Trenton Potteries Company has outstanding $411,570 of "funding certificates" which were issued to stockholders who exchanged their 8% cumulative preferred for a new issue of 8% non-cumulative preferred. These stockholders received 44%, being the amount of their dividends in arrears, in the form of "funding certificates".