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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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Corporate management also prefers issue of debentures as interest on convertible debentures is a charge against the profits while dividend on shares is paid out of and after tax profits. Several companies plan issues of convertible debentures in such a way that the addition to the equity base is extremely limited to the expanding base of operations and thus improve their overall return on capital. They also enable company to sell future issues of equity shares at a high price than the price at which its ordinary shares are selling when the convertibles are issued.

Until debentures are converted the company has a tax-advantage because interest payments are deductible business expenditure. This makes them a cheaper source of finance.


On the other hand convertible element introduces an uncertainty in the capital structure of the company as to when and how many of the debentures will be converted. If the market price of the shares rises above the conversion price the company may find that it has sold equity too cheaply. If the market price of shares falls below the expected level the problem becomes much worse as then the issue does not convert.

This affects the ability of the company to obtain further long term finance.

However, the policy of the government is to encourage issue of nonconvertible debentures. In order to implement this policy the Third and Fourth Guidelines of 1982 and 1984, as issued by the Controller of Capital Issues, clearly refer to the favourable treatment towards nonconvertible debentures. Under these guidelines certain concessions which were hitherto enjoyed by convertible debentures were withdrawn.

The three public investment institutions, namely, L.I.C., V.T.I. and G.I.C. at last came out with a scheme to support the corporate sector's buying back arrangements for non-convertible debentures." At a Commitment fee of 2.5 per cent the institutions will repurchase these debentures bought back from investors by the issuing companies, subject to the individual investor's holding not exceeding Rs. 40,000. Such repurchase will also be conditional to the issuing companies giving an undertaking that they would buy back the debentures from the holders at par. Buy-back arrangements by the issuing companies and repurchase by the public investment institutions were among the suggestions of the Pai Committee set up by the Reserve Bank of India to formulate a policy for activating a secondary market for non-convertible debentures. This scheme may also boost up the primary market.

The boost to non-convertible debenture issues as well as the reduced public interest in equity in the last two years reflect the impact of the government regulation and is an indicator of the emerging trend in the capital market. Till 1980-81 the private corporate sector relied mainly on equity issues for meeting its long-term financial requirements. In 1981·82 there was a changed scenario when convertible debenture issues enjoyed a larger public support than equity in terms of number of times the subscription. Since 1982-83 there was a dramatic change as the nonconvertible debentures have emerged as a major instrument of primary capital mobilisation by the corporate sector. The mobilisation of capital from debenture issues rose from Rs. 285 crores in 1982-83 to Rs. 408.28 crores in 1983-84. Capital issues through non-convertible debentures rose from 171.05 crores in 1982-83 to Rs. 422.47 crores in

19. See Editorial, Financial Express, Oct. 23 1982, p, 7.


1983-84. The latest official guidelines of 1984 on debenture issues are yet another step towards promoting debentures at the cost of equity.

With the advent of the non-convertible debentures'" and the enthusisatic response by the investing public, the companies have refrained from offering convertible debentures to the investing public in India.

Debenture issues, excluding rights debentures, showed a significant rise during the third quarter of 1985. They rose to 16 crores in JulySept. 1985 from Rs. 10 crores in April-June 1985. Five companies issued non-convertible debentures amounting to Rs. 16 crores. Usha Martin Industries issued the largest amount of non-convertible debentures of Rs. 7.50 crores followed by 20th Century Leasing Rs. 3 crores and Tata Burrough (Rs. 2.50 crores). (See Table 5.10)

–  –  –

(a) Non-Convertible Debentures [ The Economic Times, Oct. 28, 1985, p. 4.] A major implication of the recent repurchase scheme is that while the primary market for non-convertible debentures is still looking up, a broadbased secondary market will also thrive.

20. Sec Ravi Kapur, "Secured Debentures: Inexcase in Ten yean", Patriol, Apri14.

1984. p. 1.


Government Regulation and Debentures : Though there is encouraging trend in the debentures market, still some more refinements are called for therein in order to render the same more alluring to the ordinary investing public. It is essential that the government should take steps to frame necessary regulations. The income-tax benefits under Section 80-cC of the Income Tax Act may further be extended to the debentures issued by the new units. It may be clearly stated that the convertible debentures should be offered first to the existing shareholders. The financial institutions should also take suitable steps to popularise the debentures. The government may expressly exclude debentures from the expression "Deposits" and thus exclude the debentures from the various legal provisions which apply to the "Deposits".

In all cases where public issue is not fully absorbed by the public, the government should make it compulsory for the company concerned to issue a fully certified statement not only to the underwriters concerned but also to the stock exchange giving full particulars of the public response to the issue. Such healthy practice might prevent illusions and help the government in modifying its policies suitably as and when found necessary.

An automatic provision for a hike in the rate of interest payable on debentures will generate better response from investing public. It will help in preventing depreciation in values of the debentures already floated. It may also be considered that an annual buy-back provision at par value, atleast to small investors, will result in drawing funds from those who are unable to lock-up their resources for a longer period.

Companies may also be encouraged to issue simultaneous debentures of different durations with the redemption period of each of them being fixed in a single instalment, instead of issuing one lot of debentures maturing in three or five annual instalments as is being done at present.

Underlying the government regulation of debentures should be the official philosophy and earnestness for evolving a dependable capital market for debentures as a second string to the bow of corporate finance.

The secondary market for debentures should be developed in such a way that debentures issues are continuous rather than sporadic to meet the growing financial requirements of the corporate sector. In this respect, it is pertinent to reiterate two suggestions. First, the government should take necessary steps to bring uniformity in the rates of the stamp duty paid on the transfer of debentures all over the country.

Second. it will be worthwhile to exempt debenture interest upto Rs. 3000 from Income Tax and also to give some relief from deduction of tax at source. These steps will further encourage companies to meet their


long term and medium term financial requirements by issuing debentures and reducing their dependence on banks and financial institutions.

Convertible Cumulative Preference Shares (CCP Shares) While presenting the budget for 1985-86 the Union Finance Minister, Mr. V.P. Singh, proposed a few steps aimed at easier mobilisation of resources from the market by the corporate sector. The convertible cumulative preference shares (CCP) is one of them for diversifying the corporate capital market in the country.

The cumulative convertible preference shares offer security to the investor because he is protected from the risk associated with a probable failure of the project. Even when profits afe inadequate to pay him dividend he does not lose the right thereto as the dividend payable accumulates year after year and the preference shareholder has to be paid the accumulated and current year's dividend before the company can think of paying any dividend on equity share capital. Secondly, so long as any dividend on preference shares is unpaid and is in arrears for any year the preference shareholder is entitled to excercise voting right at the annual general and extraordinary general meetings of the company under the Companies Act. To this extent he can influence management decisions of the company.

Salient features: According to fresh guidelines tabled in the Parliament on Monday, 19th August, 1985 by the Finance Minister, Mr. V.P. Singh, the public limited companies in future will be able to issue cumulative convertible preference shares when they are setting up new projects; expanding or diversifying existing projects, raising funds for normal capital expenditure for modernisation or for working capital requirements. The amount of issue of CCP shares will be to the extent the company would be offering equity shares to the public for subscription. In case of projects assisted by financial institutions the quantum of issue would be approved by the financial institutions.

CCP shares would be deemed to be equity issue for the purpose of calculation of debt-equity ratio. The entire issue of CCP would be convertible into equity shares between the end of 3 years and 5 years and may be decided by the company and approved by the Controller of Capital Issues (CCI). The rate of preference dividend payable on CCP would be 10 per cent. The stipulation of 1:3 ratio between preference shares and equity for issue of preference shares will not be applicable for the new instrument. The face value of CCP shares will ordinarily be Rs, 100 each and shall be listed on one or more stock exchanges in the country. CCP shares will have voting rights as in the case of preference shares under the Companies Act, 1956. The guidelines say that "the


conversion of CCP shares into equity shares would be compulsory at the end of 5 years and they would not be redeemable at any stage."

The text of the Guidelines of 1985 for issue of cumulative covertible

preference shares, is as follows:

Under the Capital Issues (Control) Act 1947. all companies, whose issue of share capital is not -specifically exempted under the Capital Issues (Exemption) Order, 1969 made under Section 6 of the aforesaid Act are required to obtain the approval of the Controller of Capital Issues (CCI) in the form of consent or a letter of acknowledgement.

These guidelines are issued for the guidance of companies proposing to

issue cumulative convertible preference shares, as follows :

I. Applicability: The guidelines will apply to the issue of Cumulative Convertible Preference (CCP) Shares by Public Limited Companies which propose to raise finance.

2. Objects of Issue : The objects of the issue of the above instrument should be as under :

(a) Setting up new projects;

(b) Expansion or diversification of existing projects;

(c) Normal capital expenditure for modernisation; and (d) Working capital requirements.

3. Quantum of Issue : The amount of issue of CCP shares will be to the extent the company would be offering equity shares to the public for subscription. In case of project assisted by the financial institutions, the quantum of the issue would be approved by the financial institutions/ banks. The applicant company should submit to the Controller of Capital Issues (CCI) a realistic estimate of the project costs, along with copies of letters indicating the approval/participation of the public financial institutions in financing of the project costs.

4. Terms of Issue: On the following terms the CCP shares

will be issued :

(i) The aforesaid instrument would be deemed to be equity issue for the purpose of calculation of debt-equity ratio as may be applicable.

(ii) The entire issue of CCP would be convertible into equity shares between the end of 3 years and 5 years as may be decided by the company and approved by the CCI.

(iii) The conversion of the CCP shares into equity would be deemed as being one resulting from the process of redemption of the preference shares out of the proceeds of a fresh issue of share made for the purposes of redemption.


(iv) The rate of preference dividend payable on CCP would be 10%.

(v) The guidelines in respect of issue of preference shares regarding ratio of 1:3 as between preference shares and equity shares would not be applicable to the new instrument.

(vi) On conversion of the preference shares into equity shares, the right to receive arrears of dividend, if any, on the preference shares upto the date of conversion shall devolve on the holder of the equity shares on such conversion. The holder of equity shares shall be entitled to receive the arrears of dividend as and when the company makes profit and is able to declare such dividend.

(vii) The aforesaid preference share would have voting rights, as applicable to preference shares under the Companies Act, 1956.

(viii) The conversion of aforesaid preference shares into equity shares would be compulsory at the end of 5 years and the aforesaid preference shares would not be a redeemable at any stage.

5. Denomination of CCP: The face value of aforesaid shares will ordinarily be Rs. 100/- each.

6. Listing of CCP: The aforesaid instrument shall be listed on one or more stock exchanges in the country.

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