For this reason redeemable bonds usually carry with the redemption privilege a bonus or premium, which overcomes the investor's obj ection and adds a speculative value to the bond. It is often provided, for instance, that bonds may be redeemed at 105 on any interest bearing date, after thirty days' notice. Now, if this bond were to run until maturity, the owner would receive only par value for it. The extra five per cent represents a bonus paid to him for the redemption privilege.
The right to redeem is often quite important to the corporation, and is growing in favor. There is no reason why this feature should not exist in all bonds, provided the redemption price and other conditions are sufficiently liberal not to interfere with the mar keting of the bond. As a matter of fact, the possi bility of a high redemption premium may even im prove marketability, and thus return to the company in advance, in the original selling price of the bonds, a part of the redemption premium which it has agreed to pay. It is only thru redemption that the debtor is able to take advantage of favorable refunding con ditions which arise before maturity. Enlargement in the business or assets of the company, improvement in its credit or in the market conditions, or the neces sity of increasing its indebtedness to finance expan sions may render a refunding desirable.
If a bond issue has forty years yet to run, and, owing to favorable conditions, it may be refunded at a saving of one per cent per year in the interest rate, it is clearly in the interest of the company to pay the five per cent redemption premium and refund the bonds in order to save the forty per cent in interest during the life of the issue.
5. Income bonds.—The income bond is not fre quently used. Its name is derived from the fact that it receives no fixed interest, but merely participates in net earnings. Interest is payable only when it has been earned and the judgment of the directors is final. The bonds may have any class of security, as to the principal, and mature like other bonds upon certain fixed dates. The principal is ordinarily secured by a junior mortgage, or collateral deposited with a trustee, and the interest is payable if earned up to a certain fixed rate, usually six per cent.
The income bond is issued, as a rule, only in reor ganizations, in order to reduce the fixed interest charges and, at the same time, to give to the former bondholder, whose preference is scaled, an obliga tion which comes ahead of all capital stock, as to both principal and interest. It combines the form and security of principal of a bond with the dividend features of preferred stock. As to earnings, the in come bondholder is practically the owner of first pre ferred stock. Such bonds share the income risk of the stockholder without exercising the voting control which usually accrues to stock. Some such issues have been debentures without specific security, and no better in any particular than preferred stock. A few issues have presented the astonishing feature of pos sessing neither cumulative dividend provisions nor any measure of voting control in the absence of divi dends.
Probably the most notable issue of income bonds was that of the Central of Georgia Railway Com pany. This case well illustrates one of the chief diffi culties of income bonds: namely, that it may be a matter of dispute whether or not the interest upon them has actually been earned. This decision rests with the directors of the company, unless the bond holders can show fraud or manipulation, as they finally did succeed in showing in the Central of Geor gia case after many years of expensive litigation. In the maze of accounting procedure it is quite easy to hide the profits of large corporations, and this is par ticularly so where subsidiaries are operated.
It should be noted that income bonds are almost never justified, except in reorganization emergency. When secured by a junior lien, they may embarrass the corporation in its future borrowing, whereas pre ferred stock does not do so, and in other ways it is preferable to the income bond.
6. Nature of preferred stock.—When there is more than one class of stock, all those classes which possess special privileges are called preferred, and all the rest are known as common stock. The preference may consist of any one, or more, of three kinds: 1. In the distribution of principal upon liquida tion 2. In dividends 3. In voting power.