Income bonds give the holder almost no control, either immediate or contingent. The stipulation of their issue is only to pay inter est if earned. So failure to pay interest, unless earned, does not confer upon the holder any right to take control from the owners of the stock. Obviously the income bondholder has less control than the owner of any other secur ity we have discussed; and together with this minimum of control he assumes considerable risk. It results that the income bondholder may find that he has purchased a lawsuit rather than a security.
The Central of Georgia Railway furnishes one of the best-known examples of the in come bond. That corporation has outstand ing three issues, all put out in 1895 and due in 1945. They arc non-cumulative and bear in terest, payable only if earned, not exceeding 5 per cent in any one fiscal year. As a matter of fact, the corporation did not pay the full 5 per cent on the first incomes till 1901, paid only 3 per cent in 1902, then 5 per cent till 1908. It did not pay anything on the second incomes till 1904, then 2 per cent; 5 per cent in 1905 and 1906; 3.73 per cent in 1907; then entirely stopped paying. On the third in comes it paid 5 per cent in 1905 and 1906, no thing till then and nothing after. The income bondholders took the matter into the supreme court of Georgia. An auditor appointed by the court found that the railway company had wrongly kept back $542,000 net income of a subsidiary, the Ocean Steamship Com pany, and other items, making a total of $860,909 available beyond what the corpora tion itself had shown. The court thereupon held the company liable for full interest on the three classes of income bonds from earn ings of and in February, 1911, the corporation paid the balance of 1.27 per cent on the second preferreds and the 5 per cent on the thirds.
In November, 1909, the bondholders again brought action to recover full income interest on the three classes of bonds from earnings of 1907-08. In May, 1911, the company offered to pay, and did pay in June, the full income on the firsts for 1908, and 2.821 per cent on the seconds, and for 1909 and 1910, 2.312 per cent on the firsts. These payments were made without regard to any further claims the income bondholders might make.
It is interesting to set down the operating ratios in comparison with the interest pay ments on these income bonds before the de cision of the court.
These high operating ratios, especially the 76 per cent in 1907, the 74 per cent in 1908, and the 79 per cent in 1909, would raise a question, at least, if the company, in addi tion to holding back the net earnings of its subsidiary, were not also, under the guise of maintenance (operating), sinking earnings in really capital expenditures expected to show results later in the form of dividends on stock.
We have gone into this at such length to show a case of ill-advised apportionment of control, risk, and income. Omitting the ques tion as to whether the anticipated income would compensate for the risk, very appar ently the investors who bought the bonds should not have taken the risk without get ting more control. If they had insisted on either the contingent control of a right of foreclosure, or the active control of voting power, they would not have got into a position offering such possibilities of disputes.
Other examples of income bonds are: Florida East Coast Railway, U0,000,000 (V5,000,000 authorized) 5 per cent non-cu mulative second mortgage, due 1959; New Orleans and Northeastern Railroad, $1,500, 000 41 per cent non-cumulative income mort gage, due 1952.
Apparently the mortgage lien was stipu lated for in these cases to give the right of foreclosure on failure to pay principal. Fail tire to earn and pay interest does not give a right of foreclosure. All these bonds present the astonishing feature of being non-cumula tive without any active control.
Convertible bonds present a further class with respect to control. We have already dis cussed the somewhat limited class of convert ible preferred stocks. The number of con vertible bonds is much greater and offers a more significant form of security. When a holder converts a preferred stock into a com mon, he ordinarily affects only his risk and income and does not change the quality of his control. If a convertible bondholder, how ever, changes his bonds into stock, he jumps immediately from a control that is merely restrictive or contingent to a control that is active and immediate. He has also probably made a greater change in his risk than a converting preferred shareholder.