What Are the Pros and Cons of Debenture Stock?

Ray Hawk

Mortgages are bonds secured by real property, which makes them generally regarded as less risky than debentures.
Mortgages are bonds secured by real property, which makes them generally regarded as less risky than debentures.

Debenture stock has qualities similar to both bonds and preferred stock, which give it general advantages over common stock, in most cases. Two of the primary similarities debenture stock shares with preferred stock are scheduled, fixed payments, or dividends made to the stockholder, and, in the case of liquidation of the company, debenture stockholders will be ahead of common stock holders to be reimbursed from the sale of company assets. The main negative aspect is that it is not legally backed by company assets or collateral and is considered an equity instead of a debt instrument. This means that it is secured only on the creditworthiness and reputation of the company, and, if the company is liquidated, creditors are paid off first, then traditional bondholders, then the holders of debenture and preferred stock. At this point, there may be no capital left to reimburse debenture stockholders, even though they receive priority over their larger group of common stockholders.

Unsecured bonds are so similar to debenture stock in the United States that the terms are often considered interchangeable. Both investments are a form of voucher that acknowledges a company's debt without having any claim to company assets if it fails. Because of this, debenture stock is often issued by very large and stable corporations, and national governments who can back up the financial instruments based solely on their reputation. In the case of a government, if a financial crisis ensues, the nation can simply print more money to assure bond or debenture holders of its liquidity and financial solvency. This allows a company to borrow money by issuing debenture stock, without having to back up the borrowing with company collateral.

One of the drawbacks for these types of stock investments are that they do not give the stockholder any voting rights in the company, which is also generally true of preferred stock. Despite this limitation, convertible debentures can be converted by the stockholder to common stock, which does carry voting rights. The limitations of unsecured debt instruments like debenture stock will increase the frustration of investors who are not paid off if company liquidation issues arise, but they are not looked at in this manner by the issuer. Instead, they are seen as a form of long-term debt financing of company growth. The debenture stockholder is a lender to the issuer, like a bank, and the dividends paid out are a type of interest on the stock itself, which acts as a form of unsecured loan to the company.

Definitions for debenture vary somewhat from nation to nation. In the United States, it most strongly resembles unsecured bonds, whereas in the UK debenture is often secured, and, in Asian nations, debentures are compared to mortgages. There are also several sub-categories of debentures, including government debentures, commonly known as a Treasury bond (T-Bond) or Treasury bill (T-Bill), and exchangeable debentures, which are similar to convertible debentures with the exception that they can only be exchanged for common stock in subsidiary or affiliated companies to the one that issued them.

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