MISCELLANEOUS BONDS AND PREFERRED STOCKS 1. Debenture bonds.—We have seen that bonds are essentially of three classes : mortgage bonds, secured by real estate; collateral trust bonds, secured by per sonal property; and debenture bonds, not secured by the pledge of any specific asset. Redeemable, con vertible, participating, or income bonds are only titles indicating some important characteristic in the pay ment of principal or interest, which may apply equally well to mortgage, collateral trust, or deben ture bonds. Mortgage and collateral trust bonds have been briefly described. It remains for us to dis cuss debentures as a class.
Debentures are plain, unsupported promises to pay. Excepting long-maturity notes and the formal ity with which they are drawn, there is no difference between them and "unsecured" corporation notes. In the event of default, the only remedy of the deben ture bondholder, is to enter suit against the corpora tion, as no part of its property has been segregated for his protection.
Most government bonds are debentures, since pay ment of principal and interest depends entirely upon the taxing power of the government. In England, most railway bonds are debentures. The English investor feels that, after all, the earning power of the corporation is his only ultimate protection. Theo retically, he is right, for if the operation of a railway is interrupted by foreclosure under liens covering portions of the property, its earning power will prac tically cease, and the real protection of the lien be defeated. In practice, it makes little or no difference to the bondholders whether its bonds are all mortgage bonds or all debentures, provided all those outstand ing are upon the same basis and come in before the current liabilities.
The American investor likes specific security. The early hazardous financing of American railways seemed to demand the mortgage -bond, and it is still the predominant type. The collateral trust bond carries out the same principle, but it is better adapted to complicated holding company situations, such as have developed from the rapid combination of Ameri can railways and industrial corporations, with their small divisional mortgage bonds still outstanding.
The debenture bond in the United States has been issued principally in reorganizations for the purpose of reducing the amount of mortgage liens, and thus strengthening the remaining mortgage bonds. The New England railways have issued quite a few de benture bonds, typified by those of the Boston and Maine" and the New York, New Haven and Hart ford Railroads. Outside New England, not many of these bonds are found in the United States, either among railways or large industrial corporations.
In the absence of specific provisions to the contrary, debenture bondholders rank with other general credi tors in the payment of interest and the distribution of assets. However, it is customary, for the debentures, even tho not secured by lien, to have priority over other general creditors. When debentures are issued to keep down the mortgage debt, in reorganization or otherwise, it is usually provided that outstanding de bentures shall share in the security of any new mort gage which may be placed later upon the company's property. Otherwise, additional mortgage bonds might be issued ahead of the debentures at any time. Debenture bondholders should insist that mortgage indebtedness be strictly limited. Debentures do not carry the right of foreclosure on default, and there fore possess neither the security nor the strong con tingent control held by the junior mortgage bonds of the same company.
In order to make debenture bonds look attractive, it is customary to make them convertible into stock, either before or after some given date, and at some fixed price above par. This adds a speculative ele ment which makes some issues of convertibles highly marketable. Without the conversion privilege, the debenture bondholder is likely to feel that he loses whichever way the affairs of the company go. If the company goes under receivership or bankruptcy, he stands behind all the mortgage creditors. If the com pany is extremely profitable, the stockholder may get high dividends, but the debenture bondholder's in come and the value of his bonds are limited by a fixed interest. With the conversion privilege, deben tures share in the prosperity of the company if its stock goes to high prices.