In England the distinction between preference shares and "debenture" shares or other forms of obligation, is so hazy that owned capital almost imperceptibly merges into borrowed capital. Partly for this reason, the proportion of borrowed capital often appears somewhat smaller than in this country. For example, in water, railway, tramway, gas, and other public utility companies, the amount of loaned capital is usually limited to one-third of the total capital. The Board of Trade in railway returns for 1910 showed percentages of the various classes of railroad securities as follows:*

Ordinary stock........

37.3%

Preference and guaranteed stock.....

35.8%

Loan and debenture stock.........

26.9%

It will be noted that much of the preference and guaranteed stock would normally be considered as borrowed capital in this country, so that actual practice in the above classes of undertakings does not differ much from the practice in the United States.

The first schedule of the English Companies Consolidation Act of 1908, provides that the indebtedness of a company shall not at any time exceed the amount of its capital without the sanction of the shareholders in general meeting.

*Robert H. Whitten's report on "Regulation of Public Service Companies in Great Britain," issued by the Public Service Commission, 1st District, State of New York, 1914, pp. 26 ff.

Against the two great advantages of using borrowed capital - cheapness and ease in procuring the funds - there must be offset the obvious disadvantage, that the risk to the owners of the share capital is thereby increased. The shareholders have, of course, only an equity in the property and income of the corporation which is first subject to all prior claims of the holders of the obligations. This may not involve a serious risk in the case of corporations that have stable earnings, but when earnings fluctuate widely from year to year, even though the average return on the invested capital may be high, the position of the shareholders with a large indebtedness ahead of them may become very uncomfortable. It is for this reason that the tendency has been strong in recent years for industrial corporations to shun even small bond issues and to raise their capital only through common and preferred shares. Sometimes this cautious policy may be carried to what appears to be an extreme. Two large and powerful industrial corporations, for instance, the Pullman Company and the Singer Sewing Machine Company, have no securities outstanding except common stock. Two somewhat smaller corporations which have cleared away all their obligations, including even short-time notes and accounts, are the Plume and Atwood Manufacturing Company, in Connecticut, and the United Shoe Machinery Company.

The unsoundness of too heavy borrowing cannot be better shown than by the combined figures on the capitalization of thirteen large railway systems in the United States which were in receivers' hands in the summer of 1914. The funded debt of these thirteen railways was about 70%, and the stock issues only about 30% of their total capitalization. To lay down any exact rules as to the proper proportion of borrowed capital, would clearly be out of the question. We are forced to fall back on the general statement that capital should not be borrowed unless there is a practical certainty that both interest payments and payments on principal can be met as they fall due. This involves the further rule that the annual fixed payments of a corporation should be only a reasonable proportion, not of the average earnings, but of the lowest earnings. The fact that a corporation has made a distribution or invested big profits in one year, is small comfort if it finds itself in the following year unable to meet its obligations.

As to payments on account of principal, it has long been regarded as almost axiomatic that companies doing a stable business, such as railways and public utilities, need make no provision for paying off and retiring their funded debts. These companies, it has sometimes been said, will never cease to borrow; therefore, when one obligation matures, the proper plan is to refund it by issuing another obligation in its place. However, this principle is no longer universally accepted. In fact, at the 1915 meeting of the Investment Bankers' Association, the Committee on Railroad Bonds and Equipment Trusts recommended among other things that railroad mortgages should contain provisions for sinking funds. Even railroad corporations, if this recommendation were generally adopted, would be taking steps to pay off in cash each obligation which they incurred.