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.
A debenture - to give its literal and also its technical legal meaning - may be defined as any acknowledgment of debt which, of course, implies a promise to repay the debt. In financial practice, however, the word has gradually become restricted until it now means only an unsecured promise to repay a debt. In England a distinction is made between debenture bonds, generally called simply "debentures," and debenture stock; debenture bonds are in fixed amounts (say £20, £ 100, £200, £1,000, etc.), while debenture stock may be transferred in any amount that may happen to suit the convenience of buyer and seller. Under English practice a man may hold debenture stock in an amount, let us say, of £1263 6s. 3d., and may sell, let us say £563 4s. 2d.; while of debenture bonds his holdings and his sales must be in fixed amounts depending on the conditions of issue. Thus it will be seen that in England the distinction between debenture bonds and debenture stock is much the same as between ordinary shares and ordinary stock.
The English practice and American practice in the use that is made of debentures is entirely different. In English practice the mortgage bond is not so nearly universal as in this country, and the debenture bond or stock takes its place. We may draw a loose distinction between the two systems by saying that the American practice favors the issuance of obligations which are primarily protected as to their principal by the issuing company's assets, and as to their interest claims by the issuing company's income; while in English practice, the bondholder is protected primarily as to his interest by the priority of his claim on the issuing company's income, and is protected as to his principal only by the general credit of the issuing company. There has been some little debate at different times as to the relative merits of the two systems. The American system is criticized on the ground that, after all, the only test of the value of a company's assets is the amount of income they yield, and the English system, therefore, is not only simpler but more logical. On the other hand, it is stated that, in case the English debenture holder fails to receive his interest payments regularly, he has no further claim on which he can fall back. Hartley Withers, a leading English authority, asserts that "mortgage rights, carrying with them the power of foreclosure, are always desirable to complete the security of the debenture holder.....The absence of mortgage rights is a weakness in an otherwise watertight security."*
The debate is of little more than academic interest, for the practice of each country is firmly established and is unlikely to be changed by any argument.
In the United States, debenture bonds are quite commonly used in railroad reorganizations, in the general scaling down of claims upon the assets and income of the corporation. There will be references to some such cases in connection with the later study in this volume of reorganization practice. In other cases, debentures have been issued by American cor-porations in high credit, simply because they preferred the simplicity of the debenture form, and were able by reason of their general credit to sell them on a satisfactory basis. This has been true in the past, particularly of the New England railroads, the New York, New Haven and Hartford, and the Boston and Maine.
Still another case that calls for debenture bonds exists when a small corporation which has a relatively small amount of tangible assets, but possesses good-will and other intangible assets of high value, desires to make a long-term loan. Inasmuch as a corporation of this type does not have the proper basis for either a mortgage bond issue or a collateral trust bond issue, it is likely to fall back on a debenture bond issue. This is especially true, for example, of publishing companies, many of which are well established and can conservatively put out a long-term loan and yet possess tangible assets of comparatively small and uncertain value. Following is a form of debenture bond which has recently been used by a small company of this type, and which is suitable for use in similar cases:
* Hartley Withers on "Stocks and Shares," p. 96.