Income bonds may be briefly described as almost the exact opposite of debentures. The debenture has primarily a claim on income, with little or no specific security for the repayment of the principal. The income bond is usually secured as to its principal by a mortgage lien of some kind, but has no claim for interest payments except as and when the issuing corporation has a surplus of earnings over and above all prior claims. The income bond is a hybrid and frequently possesses few of the attractive features either of ordinary bonds or of stock. It is seldom accepted by investors from choice. Most of the issues of income bonds now outstanding are the products of reorganization. In the general scaling down of creditors' claims which attends every successful reorganization, some of the bondholders are likely to be required to give up their claim to a fixed income, and to accept the claim which is possessed by the income bond to a fixed income only when it is earned.

Theoretically, this arrangement is fair enough and offers junior bondholders of an insolvent corporation all that they can reasonably expect to obtain. When income bonds were first issued extensively in the United States, during the numerous railroad reorganizations of the 8o's, they were generally regarded as an ingenious and praiseworthy device, but later experience has not confirmed this favorable first impression. Difficulties continually arise out of the fact that the determination of net earnings in a large corporation is not a purely mathematical process, but involves much discretion and continually gives rise to differences of opinion. It is to the interest of the common stockholders, who usually have control of the corporation, to defer payments to income bondholders as long as possible, or until the time arrives when dividends may be distributed also to the stockholders. It is easy enough for them to prevent payment of interest on income bonds if they so desire, by instructing the auditor to charge many expenditures of a capital nature into operating expenses, thus reducing the nominal showing of net earnings.

The best-known case of this kind is that of the Central of Georgia Railway Company, which issued in its reorganization of 1895, three series of income bonds, all falling due in 1945. For several years the holders of income bonds, to whom no payments were made, protested that they were not receiving fair treatment. Finally, in 1913, after long litigation, an auditor was appointed by the court and found that the Ocean Steamship Company, all of the stock of which was owned by the Central of Georgia Railway Company, had been earning large profits which were never taken into the published accounts of the Central of Georgia Railway Company. The earnings of the Ocean Steamship Company were turned over to the parent corporation under the fiction of a "loan" which was never intended to be repaid. Counsel for the Railway Company did not deny the facts but argued on the strictly technical ground that so long as dividends had not been declared by the directors of the Ocean Steamship Company, it was impossible to include these earnings in the income account of the Central of Georgia- Railway Company. It is a relief to find that the court disregarded this shallow pretext and took the common-sense view that the earnings of the Central of Georgia Railway included the earnings of its subsidiary company. In this instance the income bondholders finally won their case and are now receiving payments of interest. It was, however, a long and hard battle which offers little encouragement to investors to put their money into securities of this type. It has been well remarked in this connection that "the income bondholder may find that he has purchased a lawsuit rather than a security."*

Sometimes the holders of income bonds are given some of the rights of stockholders. The income bondholders of the New York Railways Company, which owns a number of the surface street railway lines in New York City, have the right to elect five out of eleven directors of that company. In the latter part of 1914, an active campaign to secure the proxies of income bondholders was conducted by the president of the New York Life Insurance Company, with the cooperation of other investors. It was announced that this campaign was based on the belief that the bonds were entitled to more interest than they had been receiving and that it was desired to elect directors who took the same view. "It should be remembered," it was stated, "that these bonds are not cumulative, and any income to which they are fairly entitled not currently received is utterly lost, unless the court shall decide to order a new accounting from the date of reorganization. A suit calling for such action is now pending".

That holders of income bonds may sometimes have to content themselves for a long period without obtaining either income or a return of any of their principal is clear from the report of the Comstock Tunnel Company. This company has outstanding $2,769,000 first income 4's, on which no interest has been paid since 1892. An extraordinarily weak claim is that of the Reading deferred income bonds, which are not entitled to interest until after the common stock has received 6% dividends.

* Lyon on "Capitalization," p. 49.

Although new issues of income bonds have been rare in recent years, the Hudson and Manhattan Company put out in 1913 a series of contingent income bonds. In industrial corporations they are rarely to be found. Out of 40 or more industrial security issues discussed in Dewing's "Corporate Promotions and Reorganizations," only two are income bonds, those of the Mount Vernon-Woodberry Company and the Standard Rope and Twine Company. The Mount Vernon-Woodberry bonds were secured by a second mortgage on all the fixed assets and a direct lien on all the merchandise and quick assets. They proved a constant source of controversy and greatly handicapped the company in securing short-term bank credit which is especially essential in textile manufacturing. The indenture of these income bonds was faulty in that it made no provision for allowing depreciation before figuring net earnings, thus giving rise to many impossible demands on the part of the dissatisfied income bondholders.*

Income bonds and stock are used to a limited extent also in English practice. The same objections, however, have arisen there as in this country, and the tendency is in favor of other securities which give less room for misunderstanding and controversy. The Lancashire Power Construction Company, Ltd., has outstanding an issue of income stock which was issued as a bonus to subscribers to debenture stock. The income stock is entitled to 75% of the net profits after deducting interest on bonds and debentures, and the principal is repayable, in case the company is wound up, after prior debts have been liquidated.

* Dewing's "Corporate Promotions and Reorganizations," pp. 340, 363, 606.