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.
Up to the present point in this chapter we have considered only the relations between security issues and the needs or notions of the prospective purchaser of these issues. It is, of course, clear that there must be a correspondence also between the security issues and the needs of the corporation. The mere fact that a security of a given type is thought to be easily salable is not the final reason for issuing just that security. The corporation's interests may best be served by some other type of security, and it may be necessary - in fact, generally is necessary - to make a compromise.
From the corporation's standpoint, the outstanding securities should be in correct relation both to the assets of the corporation and to its earnings. If this correct relation - or an approximation to it - is not secured, then one of two undesirable results must follow: either the capital required is secured upon terms that are more or less onerous and wasteful, or, on the other hand, the corporation is burdened with claims which it may not be able to meet and which, therefore, endanger its continued existence. The first-named fault is probably both less frequent and less to be condemned than the second fault.
* Undoubtedly the National Cordage Company was in unsound financial condition, but it need not necessarily have gone down just at this time if it had not been for the imprudence of the directorate in failing to give due consideration to the general market conditions. It seems probable that their action was hasty and taken without proper financial advice. (See remarks in Dewing's "Corporate Promotions and Reorganizations").
Some conspicuous examples of wastefulness in raising corporate capital may readily be picked out. The Singer Sewing Machine Company, although it possesses tangible assets of enormous value, has no bonds or preferred shares outstanding, but only its $60,000,000 of common shares. The same thing is true of the Pullman Company which has only its one issue of $20,000,000 common outstanding; the Mergenthaier Linotype Company with its one issue of $12,786,700 common stock; and the Arlington Mills with $6,000,000 in common stock. All these corporations could sell with reasonable safety - and during many years in the past could have sold - bond or preferred share issues by means of which capital could be raised at a rate considerably less than through the issue of common shares. All these corporations, it is true, are exceptionally prosperous; their shareholders are well satisfied and perhaps would prefer the complete safety of their present position to the qualified safety which they would enjoy if prior claims ranked ahead of them. Nevertheless, it is true that earnings on the common shares would no doubt be considerably higher if the required capital had been obtained in part through bond and preferred share issues. The truth of the case is that the assets of all these corporations have been accumulated chiefly out of surplus earnings and the profits have been so large that there has been no occasion to depend upon security issues to any great extent for fresh capital. The objection that is here raised to their present arrangement of security issues is, therefore, it may be freely granted, of an academic nature. If these and other prosperous corporations which have relied wholly on common stock issues have erred at all, it has clearly been on the side of conservatism and safety.