Question

Explain the meaning of debentures. State any four disadvantages of debentures.

Answer 1

Debentures are common securities issued under borrowed fund capital. Debentures are instruments for raising long-term debt capital. Debentures are called creditor ship securities because debenture holders are called creditors of a company.

A debenture can be defined as ‘a document or a certificate” issued by a company under its seal as an acknowledgment of its debt. Holder of debenture certificate is called debenture holder. Following are disadvantages of Debenture :

Fixed Obligation: Payment of interest is a fixed commitment of the organisation whether it is earning profit or not. Sometimes companies have to borrow funds for payment of interest to debenture holders.

Reduction in Credibility: Financial institutions and lenders hesitate to lend funds in the companies having more of debentures. The credit-worthiness of a company which has issued a large number of debentures is low.

Charge on Assets: Usually, debentures are issued against securities of fixed assets. During the time of depression, if a company is unable to pay the regular amount of interest and finds it difficult to repay the amount, in this situation the debenture holders can have claim over the assets of the company.

No Voting Rights: The debenture holders are not allowed to vote in the management of the company. All the decisions regarding interest rate for debentures are taken by the equity shareholders only. Therefore, they remain at the mercy of equity shareholders.