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«v CAPITAL FORMATION: SHARES AND DEBENTURES o Introduction o Capital Formation, Market Trend o Banks and Money Supply Capital Investment Profitability ...»

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by way of their initial contribution as discussed above. On the other hand, debt is provided by financial institutions and is also often obtained by raising loans in the market. The memorandum of association of a company provides for the borrowing powers of a company. The corporate sector raises loans from the market by way of issue of debentures.

The past three years were a watershed in the evolution of the capital market in India both because of the launching of new instruments as well as the modifications of the old ones. The debentures have made a remarkable contribution to the financial requirements of the private corporate sector. The issue of debentures is now regarded as a significant means for raising capital from the market as compared to other modes viz. equity shares, preference shares, rights issues and bonus as shares. Debentures are commonly issued in a manner similar to the issue of shares through prospectus of company. The provisions of the Companies Act relating to prospectus also apply to debentures where they are issued to the public.

Nature aod classification The term 'debenture' has not been given an exhaustive definition in the Companies Act except for an inclusive definition of the term under Section 2(12), where it states "debenture includes debenture stock, bonds and any other securities of company whether constituting a charge on the assets of the company or not". A debenture is an acknowledgement of a debt and contains a contract for the payment of the principal sum at a specified date and for the payment of interest at a fixed rate per cent until the principal sum becomes repayable and it mayor may not give a charge on the assets of the company as security for the loan.

A debenture holder is a creditor of a company while a share holder is an owner. A debenture is a document given by a company as an evidence of debt to the holder usually arising out of a loan and most commonly secured by a charge. The debentures are secured by a mortgage of the assets of the company. Debentures are classified into four classes: (i) registered debentures payable to a registered holder and debentures payable to a bearer, (ii) secured and unsecured debentures, (iii) redeemable and perpetual debentures and (iv) convertible and nonconvertible debentures.

Section 125 of the Companies Act provides that where any charge (including mortgage) is created for the purpose of issuing debentures, it should be registered with the Registrar of Companies within 30 days, otherwise it will be void against creditors or liquidators. The debentures are registered in the name of the holders in the books of the company. They are transferable in the same way as shares. Interest

214 GOVERNMENT REGULATION OF CORPORATE SECTOR

on such a debenture is payable to the registered holder or to the order of the registered holder. A company may issue debentures payable to the bearer. In the case of such bearer debentures the company keeps a register of debenture-holders and they are transferable by a mere delivery of the debentures to the transferee. But if such bearer debentures are secured they must be entered in the register of charges.

Debentures issued by a company may be secured or unsecured. Debentures which do not carry any charge on the assets of the company are unsecured, but if some assets or property of the company are charged in favour of the debenture holders, the debentures are deemed to be secured.

Generally the debentures issued by a company are redeemable. In the case of such debentures the principal money is paid off to the investor on the expiry of the fixed term. Debentures may be redeemed either at the issue price or at a higher price. Redeemed debentures can be reissued by the company.

Perpetual debentures are known as irredeemable debentures. Such debentures are issued with no fixed date for redemption. Such debentures are payable only in the event of winding up or some serious default by the company or are payable at a remote period. In the case of perpetual debentures the creditors cannot compel the company to redeem them and there is no time limit for the company within which they are bound to pay.

Debentures are usually issued in a series with a Pari Passu clause and they are to be discharged rateably. In the event of a deficiency of assets to satisfy the whole debt secured by the issue of debentures, the amount is distributed in proportion to the amount owing to each of them.

From tbe investor's point of view convertible debentures are most popular. Convertible debentures can be converted into ordinary shares of the same company at the option of the shareholder under specified terms and conditions. These debentures are just like a fixed income security with a par value and they have a fixed maturity date. They earn a fixed interest per annum. But they have a potential value as equity shares in that they can be exchanged for a certain number of shares issued by the company. The terms of convertible debentures relate to the period during which option to convert can be exercised and the number of ordinary shares into which the debentures are convertible.

The terms of convertiblity vary from one issue to another and from one company to another. Thus, in some cases the debentures may be convertible at the time of maturity, in some other cases they may be convertible during some specified period after the issue. In some other cases the debentures cannot be converted until some period lapses.





CAPITAL FORMATION: SHARES AND DEBENTURES

Convertible debentures offer advantages to both issuing companies and investors. From the point of view of the company, conversion is an important method resulting in complete extinction of the funded debt through conversion into equity. Conversion facility imparts a measure of flexibility to the capital structure of the company. When the bonds are converted, loan capital of the company goes down. Conversion helps the company to raise funds at a lower cost. It also helps the broadening of the share ownership and enables the company to find a willing market. From the investors' point of view, it is an ideal investment with high yield, low risk and potential capital appreciation.

Investors are more attracted by these convertible bonds because they offer safety of principal as well as interest and at the same time give them an opportunity to share the profits of the company. Another advantage is that when the equity price goes up the price of these bonds also go up. But even if the equity price goes down the price of these, payable by the company to the investors on maturity of debentures, remains the same as their face value.

A non-convertible debenture is a debt and it cannot be converted into equity. There is a growing interest of the public and the companies in the issue of non-convertible debentures. The non-convertible debentures are chapter then term loans provided by commercial banks. The enforcement of the provisions of the convertibility clause and interventions in the affairs of the companies by the financial institutions might possibly explain the reason for giving boost to non-convertible debenture issues.

Popularity of Issue of Debentures: The public issue of debentures was quite small during the seventies. However, an important recent development in the capital market that needs to be noted is the immense popularity of debentures. At least till 1966 convertible debentures, as a form of corporate financing, were less known in India than in the Western Countries. In 1966 Standard Mills Co. made a public issue of convertible bonds and was well received by the investors. Again the company made another public issue of convertible bonds in 1971-72 and the response for the second issue was also quite encouraging. In the subsequent period several companies like Bharat Bijlee, Gamphor and Allied Products, Metal Box, and National Machinery Manufacturers, made public issuses of convertible bonds and the public response was uniformally encouraging. Other convertible debentures issued recently which deserve a special mention are Reliance Textiles Industries, Tata Engineering, Indian Rayon, Raymond Woollen and East India Hotels.

The total debentures issued during the 1979 amounted to Rs. 66.8 crores (48.1 per cent of the total capital from market) and during the

216 GOVERNMENT REGULATION OF CORPORATE SECTOR

first half of 1980 the debentures issued amounted to Rs. 26.7 crores (41.1 per cent of the total capital raised from the market) as against Rs. 14.2 crores (28.0 per cent of the total capital raised from the market) in the corresponding period of the previous year. Mobilisation of capital from debenture issues rose from Rs. 285 crores in 1982-83 to Rs.408.28 crores in 1983-84 (See Table 5.9). During April-August 1984 sanctions for debentures touched Rs.'394.3 crores as against Rs. 213.7 crores in the same period of the previous year.

There has been, of late, a certain amount of activity in non-convertible debentures with companies offering a fixed rate of interest of 15 per cent per annum plus a redemption bonus of 5 per cent. An interest rate of 15 per cent per annum is extremely high rate. Apart from this the interest is assured. Other highlights are easy marketability, total security against fixed assets, complete liquidity with guaranteed buyback up to Rs. 40000/- and an upward review of interest as per government policy. With the advent of the non-convertible debentures and the enthusiastic response they have received, the companies have refrained from offering convertible debentures to the Indian investing public.

When and to what tune a company will issue debentures will depend upon a number of factors, i.e. the type of concern, its future profitability, financial position, state of capital market, etc. During the periods of depression and stagnancy in the market, debentures are issued as the risk involved is minimum. In times of a boom in the market equity issues are preferred. When a company reaches a high rate of growth and is expected to grow faster, gearing of capital is being done through debenture issues as it would ensure continued profits to equity holders at a larger rate. If the rate of increase of profits is higher than the debenture interest rate the equity holders would gain benefit.

Besides the issue of debentures would not affect the stability of management. It would neither dilute equity dividends nor their ownership.

The companies have to obtain a specific consent from the Controller of Capital Issues for proposals regarding issue of debentures. No such permission is necessary in the case of convertible debentures exclusively placed with financial institutions. A proposal for the issue of debentures is based on several factors like the purpose of the issue, whether the debenture would bear a reasonable proportion to the equity and resources, whether the security offered is adequate and whether the company would be able to service the debentures without any difficulty?

Generally debentures are issued by running companies. These are

CAPITAL FORMATION: SHARES AND DEBENTURES

secured by mortgage of some form of assets which only running companies can do. Interest on debentures is paid out of earnings whether profits are there or not. Thus, the debentures have become largely a means of transferring funds from public financial institutions, banks, charitable trusts, etc. to the private corporate sector. Individual investors also make their vital contribution through the debentures.

The main cause of the low public demand for debentures until recently is attributed to the low interest rates. The interest rates on debentures are controlled by the Controller of Capital Issues at the time of the issue. The interest rate on debentures (ceiling rate) was 7.0 per cent in 1963-64 and raised to 8.0 per cent in 1970-71. It was again raised to 10.5 per cent in 1974-75 and 11.0 per cent in 1979-80 and 13.5 per cent in 1981-82.

In the fiscal year 1981-82 there were hardly any takers for nonconvertible debentures. While equity issues in that period had a subscription 4.08 times the issue and convertible debentures 6.04 times, in respect of non-convertible debentures this was a depressing 0.55 per cent, which implied a substantial under-subscription. In sharp contrast mobilisation of capital from debenture issue rose from Rs. 285 crores in 1982-83 to Rs. 408.28 crores in 1983-8415 even as sanctions declined marginally from Rs. 460 crores to Rs. 452. 96 crores in the same period.

The growing disinterest in equity is indicated also by the fact that, in the financial year 1983-84, 93 per cent of the total debenture issues was accounted for by non-convertible debentures, which was in striking contrast to the overwhelming public preference for convertible debentures in 1981-82. The massive shift from convertible to non-convertible debentures, no doubt, has the same implications as the increasing lack of investor interest in equity issues of public limited companies.

Regulation and Guidelines on Debentures: The unexpected development of the corporate working capital led the Central Government to seriously think of evolving an alternative source of mobilization of funds. As a first step in this direction, the Controller of Capital Issues issued the guidelines for issue of 'rights' debentures by public limited companies for working capital requirements on September 13,

1978. These guidelines (The First Guidelines) confined only to rights debentures were having limited scope from the very provisions thereof.

After assessing the efficacy of these guidelines for two years, the government considered it expendient to enlarge the application of such guidelines and also render them more attractive as well as flexible. Such a

15. See Table 5.9.218 GOVERNMENT REGULATION OF CORPORATE SECTOR

pragmatic policy was reflected in the guidelines for issue of debentures by public limited companies issued by the Controller of Capital Issues on October 27, 1980 (the Second Guidelines). This was supplemental to and not in supersession of the First Guidelines. Despite possessed of favourable features, the second guidelines did not produce the results to the extent envisaged. In fact non-convertible debentures, as a source of finance, remained almost barren.



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