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Preferred stock financing Wong, Chuk-Yan 1989

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PREFERRED  STOCK  FINANCING  by CHUK-YAN B.B.A.,  A  The  THESIS  University  SUBMITTED  THE MASTER  Chinese  WONG  IN  of  Hong  PARTIAL FULFILLMENT  REQUIREMENTS FOR THE OF  SCIENCE IN  Kong,  DEGREE  BUSINESS  1984  OF  OF  ADMINISTRATION  in THE Faculty  of  We  FACULTY  G R A D U A T E STUDIES  Commerce  and  accept  thesis  to  THE  OF  this  the  UNIVERSITY 24  Business  required  OF April  as  Administration  conforming  standard  BRITISH  COLUMBIA  1989  © Chuk-Yan W o n g ,  1989  In presenting this thesis in partial fulfilment of the requirements for an advanced degree at The University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the Head of my Department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission.  Faculty of  C o m m e r c e and  Business  The University of British Columbia 2075 Wesbrook Place Vancouver, Canada V6T 1W5  Date:  24  April  1989  Administration  ABSTRACT  This  paper  choice  among  suggests  that  less  issue  bonds,  preferred  stock,  issuing preferred  In  that  financially  the  empirical  financing. information  firms  that  riskier.  model and  to  investigate  common  stock are  stock.  characterized  issue bonds, firms  Compared  to  firms  stock  are  bigger,  less  addition,  the  results  suggest  common  stock  and  partial  support  to  that  that  liquid,  preferred  corporate  financing  The  empirical  evidence  by a number issue  issue  riskier,  that  the  an  having  industry  stock.  preferred  common  and  Utilities  of  financial  stock  stock,  larger  difference tend  to  are firms  growth exists  favor  in the  former.  results  over-  and  between  the  incentives  to  liquid,  The  the  logit  preferred  choice  use of  multinomial  Compared  opportunities. the  the  that firms  attributes. smaller,  uses  also  lend  distressed firms evidence  hypothesis and  which  also  the  states  the  results  more  are  that  financial  likely  consistent  under-investment  Although about  is  are  the  with  firms  incentives generally  characteristics of  to  the  ii  distress hypothesis which  issue preferred  the  can  solution use  to  preferred  caused  by  mixed,  they  common do  stock.  In  adverse stock  firms that issue preferred  addition, investment  to  equity  provide  holds  eliminate and  some stock.  debt  valuable  TABLE  OF CONTENTS  Abstract  ii  List of Tables  v  Acknowledgements  vi  I. II.  INTRODUCTION  1  PREFERRED  5  A. B. C. D. E. III.  IV.  V.  STOCK  The Hybrid Nature of Preferred Stock Omission of The Preferred Dividend Tax Treatment of Preferred Stock Dividend Preferred Stock Financing in the U.S Types of Preferred Stock  in the  LITERATURE REVIEW A. Preferred Stock B. Corporate Financing Choice  U.S  13 13 20  1  HYPOTHESES A. The Financial Distress Hypothesis B. The Solution to Adverse Investment MODEL AND METHOLODGY A. The Multinomial Logit M o d e l B. The Logit M o d e l of Corporate  5 7 8 9 12  '. Incentives  Hypothesis  Financing Choice  22 23 25 29 31 33  VI.  EMPIRICAL SPECIFICATIONS A. Empirical Procedures B. Deviation from the Target Ratio C . Determinants of the Optimal Debt Ratio 1. Firm Size 2. Asset Composition 3. Bankruptcy Risk 4. Growth Opportunities 5. Tax D. The Financial Conditions of the Firm E. Market Conditions F. Industry Classification G. Summary of Predictions  36 36 37 39 39 40 41 43 44 45 46 48 48  VII.  SAMPLE A N D S O U R C E S A. The Sample B. Sources of Data  52 52 54  OF  DATA  VIII. RESULTS A N D DISCUSSIONS A. Univariate Analysis B. Multivariate Analysis  57 57 61 iii  IX. X.  LIMITATIONS SUMMARY  AND CONCLUDING  .• REMARKS  72 74  BIBLIOGRAPHY  75  Appendix  84  I  iv  . List Table  I : Gross  Table  II  New  : Preferred  Security Issues  Stock Offerings  of  Tables  in the by  U.S.,  1968-1987  Utilities and  10  Non-Utilities  in the  U.S.,  1968-1986  11  Table  111 : Variable  Table  IV : Predicted Effects of Firm Attributes on Corporate A m o n g Bonds, C o m m o n Stock, and Preferred Stock  Table V  : Sample  Table VI  : Sample  Table VII  : Croup  Definitions  of of  IX  : Univariate  Table X : Correlation Table XI  : Maximum  Common  Bond,  Means  Table VIII : Univariate Table  Bond,  49  of  Common  Matrix  Stock, and  Preferred  51 Stock  Preferred  Independent Variables in the  Tests of Tests of  Stock, and  Financing C h o i c e  Significance: Analysis of  Stock  the  Variables  Likelihood Estimates for  in the the  Issues by  Logit M o d e l  Variance  Significance: Duncan's Multiple for  Issues by Year  Range Test  58  61 63  Logit  Table Xll(a) : Predicted and Actual Effects of Firm Attributes on Financing C h o i c e Between Bonds and Preferred Stock  64  Corporate  Table Xll(b) : Predicted and Actual Effects of Firm Attributes on Corporate Financing C h o i c e Between C o m m o n Stock and Preferred Stock  v  Industry 56  59  Model  Multinomial  ..55  71  71  ACKNOWLEDGEMENTS  I  am  greatly  assistance thanks  without  go  to  motivation, impatient helped  am  the  Dr.  of  ways  to  they  to  helped  their  encouragement,  than  it was  my  not  who  have  research  Robert  Heinkel  the  entire  both  Fu, Man-kit me.  patience,  His  fruition.  advice were  Yu-Ming  could  questions.  Throughout  statistical  thesis  individuals  Of and  keen I  Josef  Dr.  project,  also Piet  Lai, Wing-Fat  course, love  my  deepest  since the  anticipated.  vi  Chan,  was  like  Rob's  indispensable for  who  and  de  who  busy or  suggestions  served  criticism  completion.  thanks  project  too  initial  acknowledge  helpful  and  heartfelt  provided  never  to  generous  My  thorough  Jong,  its  their  completed.  supervisor,  interest  would  and  rendered  been  and constant encouragement.  my  Dr.  many  Zechner,  project  help  the  this  Josef  this  committee.  thankful  many  which  answer  bring  invaluable  to  critical review, to  gratitude thesis  indebted  In  and  with  on  Piet's  addition,  Ka-Lung Leung for go  took  to  my  longer  to  my  family  I  the for  complete  To and for  the  to  inspiration  the they  my  mother,  memory gave  of and  Y e e - C h u n Chan, my father,  Mai-Kai  sharing their  vii  Wong,  respect for  knowledge.  I.  Preferred  stock  Most  the  of  between  is  The  and  to  hybrid  preferred  bonds  and  corporations  close  in  gaining  to  a  the  U.S.,  as  in  a  both  In  sale  amount  in  relation  decline  in  popularity,  remained  In  the  a long-term  U.S.,  corporations, exclude stocks  to  from [see,  to  follows  among  to  late  the  and  the  it  has  banks. 1950s,  long-term  of  new other  the  major  taxable  income  85  fact,  preferred capital.  This  has  not  particularly buyers percent  Mclnish  and  of  of  the  the  used  (1980)  in  a  In  stock  utilities  of  lesser in  the  Despite  this  extinct  but  and  non-financial  because  Brealey  come  outstanding  become  received  most  once  the  be  stock  of  public  capital.  and  can  manifested in  other  between  position  and  stock  preferred  had  clearly  and  may  stock  by  stock  dividends  stock  financing  companies  preferred  Puglisi  1  out  the  intermediate  long-term  faded  from  security.  Second,  stock  choice  preferred  preferred  was  insurance of  are  in  was  preferred  that  composite  preferred stock  sources  funds.  constitute  In  preferred  view  stock.  of  excluded  of  of  financing.  problem  is  frequently  major  source of  a  role  been  of  stock  stock  properties  issues  preferred  investors,  but  corporate  the  traditional  minor,  of  subject  common  not  of  example,  preferred  to  characteristics that  that  if  area  directed  nothing  bonds  although  the  corporate  for  is  possess  of  the  that  drawn  it  modest,  source the  that  It  popularity  extinction.  importance decline  played  typical  is  in the  reasons. First, the  tends  those  most  is  implies  studying  has  and  of  stock.  by  is  ignored  structure  attention  a number  common  inferred at  It  little  stock  a subject  capital  equity.  security  words,  been on  relatively  attributed a  long  literature  debt  analysis. be  has  INTRODUCTION  they  on  can  preferred  and  Myers  INTRODUCTION (1984)].  By  1  contrast,  comparatively received  While  tax  weaker. They  may  from  it  taxable  is  corporations for  the  constitutes  outside  capital  Heinkel  and  light  role  argument  for  the  hypothesizes  lies  on  without distribute stock.  In  a  that  The  its  the  principal  of use  vague  of  no  stock  preferred stock  attractiveness  preferred  to  to  hold  the  first  treatment  of  of  flexibility reduced dividends  less  the  stock  which of  for  preferred  $100  of  the  stock  allows  work  financing  an  of  the  stock  is  dividends  use  by  the  recent  has  been  done  of  corporations. Donaldson  to  to  financially  in  these  the  incentive  pass event for  firms  up  the  to  to  throw early  (1962),  who  financial  distressed  use  by  An  having  the  raise  work  preferred  that  for  demand  firms  Until  from  to  income  corporate  attractive  them  bankruptcy  dividend  its  obvious.  originates  primarily  provides  much  account  in  is  of  theoretical  preferred  risk  force  that and  virtually  preferred  preferred  The  up  tax  driving  motivations  (1988),  dividend  penalty.  individuals  exclude  favorable  somewhat  Zechner  the  the  the  2  are  on  difficulties.  that  stock,  only  for  2  income.  clear  preferred  motive  /  firm of  firms  dividends fails  to  preferred  3  different  manner,  Heinkel  and  Zechner  (1988)  consider  using  the  privilege  of  Recent changes in the U.S. tax code (the Tax Reform Act of 1986) have reduced the corporate dividend exclusion from 85 percent to 80 percent. It should be noted that c o m m o n stock also offers the same tax advantages as preferred stock. O n e different motive for corporations to hold preferred stock rather than c o m m o n stock is that it provides a steady stream of dividends with smaller price fluctuations than c o m m o n stock. This is attractive to those seeking stable income from their investments. 1  2  It can be argued that c o m m o n stock is also an attractive alternative in this regard. When a firm is having financial distress, it may well cut or suspend c o m m o n dividends without assuming any risk of going bankrupt. As will be discussed later, the notion of pecking order [see, among others, Myers (1984)] helps shed some light on the preference for preferred stock over c o m m o n stock. 3  INTRODUCTION deferring  preferred  two-period the  model  adverse  project  the  preferred use  Their  are tested  Despite  in which  investment  quality.  some  preferred  number  of  long-term  1.  find  to  a  instead  regarding  these  choices, based firms  namely,  a  vis-a-vis growth  opportunities  but not least,  arise  from  They  develop  as a solution  information  important  insights  financing the  particular,  the  between  the  underlying  provide  to  of  use  empirical  to  a  eliminate  asymmetry  implications  of  a set of that  motivation in  preferred is  This stock  directed  financial it  for  the  understanding  corporations.  paper  probability  multinomial  to  about  of "which  to  omission  the value  of and  paper  explores  as  source  a  the  attributes  chooses  common  and Heinkel  following  that  issue  model  stock,  offerings  over  and less liquid  firms  that  utilities  are  which  a of  two  describes an  preferred  stock  bigger,  riskier,  likely to issue preferred  tend  to  favor  the  stock,  the period  are more  use of  (1988)  hypotheses  capital.  incorporates  and preferred  riskier  are more  and Zechner's  stock as long-term  logit  of security  Also,  can be used  some  Donaldson's (1962)  are smaller,  bonds.  projects.  instruments, and  bonds,  o n a sample  stock  the  the use of preferred  ends,  that  in  the  related  and  of other  to investigate  provides  in  In  firm  positive-NPV  that  rationales  relationship  individual  Last  both  questions  objectives:  preferred  difference  financing.  funding  study.  stock  principal  To  model  apparent  for  incentives  in this  dividends,  of  2.  dividends  / 3  the  is used.  1977 to  three  financing  The evidence  1986 shows  that  likely to issue preferred  stock  less  larger  liquid,  and  have  stock vis-a-vis c o m m o n stock. common  stock  in a decision  INTRODUCTION between  The  common  paper  is  characteristics  and  organized of  III  summarizes  studies  on  corporate  based.  Section  IV  model  model.  Section  Section  VII  empirical  VI  findings  study. The  vehicle  paper  and  and  the their  on  choice  and  describes  describes  and  literature  financing  used  following  stock  the  4  stock.  the  outlines  as a financing  statistical  in  preferred  Section  stock  preferred  /  and  provides the  sample  its  on  Section  in  stock  and  the  model  hypotheses  for  the  interpretations.  the  model  sources Section  concludes with a summary  and  of IX  financing  in  this  the  use  of  Section  use and  data.  of  the  U.S.  study  is  preferred the logit  proxies.  VIII reports  limitiations  the  empirical  presents  empirical  Section  remarks.  V  of  multinomial  their  discusses the  some  in  used  on  rationales  the  some  describes some  predictions.  in  discusses  corporate  which the  II  respective  variables and  use  preferred  describes their  format.  of  the the  II.  A.  THE  HYBRID  Preferred  stock  some  the  of  Legally  speaking, and  Nevertheless, voting  it  from  advantage  of  issue.  On  the  right  is  the  preference prior  Returns common  is  similar  exceedingly  arise. stock,  preferred  of  stockholders.  common  stock  until  preferred  to  when  come  not  a  the  [Francis  (1986),  the  issuing  chapter  stockholders  20].  enjoy  full do.  stockholders,  preferred  stock  the  that  mainly  in  the  dividend have  not  regularly  bond form  or of  expense  cash  a  been  prior  a  a  priorities  issue,  voting minority  may  also  within  the  take can paid.  claim  and  dividends  interest  dividends has  made,  stock  consolidations, increases  stockholders no  common  elect  stock  like  offers  stockholders  relative  mergers,  a  to  preferred  affecting  new  that  from  stockholders  include  preferred  results  are  Nonvoting  5  of  stockholders  questions  usually  c o m m o n stocks.  common  tax-deductible  stockholders  combines  as  a  preferred  which  ownership  preferred  payments  stipulates  of  of  corporation  of  payments, This  that  preferred  authorization  security  attributes  stock  control  directors.  hybrid  portion  find  common of  a  the  a  Such circumstances  dividend  common  of  the  dividend  vote  stock are  of  dilution  of  as  common to  of  granted  to  to  rare  view  board  rights  dividends,  liquidation,  of  viewed  represents  control  the  the  preferred  distribution  thus  always  section  on  thus  STOCK  STOCK  and some  stock  occasion when  to  been  bonds  point  nearly  given  of  avoiding  representation  PREFERRED  traditionally  and  the  OF  preferred  is  privileges  Hence,  in  has  features  corporation  be  NATURE  PREFERRED  on  the  which,  payments.  In  precedence be In  paid the  assets  to  like. like the over  on  the  event  of  common  PREFERRED S T O C K stockholders. provides future part  their  it,  Preferred  preferred  date.  Known  or  a  aside  provides the  firm  investors price, close  some  stock is like  of  cumulative  recovering  dividend  omitted  be  made  clause  which  dividends  misses a preferred  but must  of  bond  fund.  conversion  year  or  to  call  dividend,  up in a later  year  of  its  of  lots.  periodically  each year the  bonds  Under  option,  preferred fund  the  support  obligated  to  in the market original  that  have  it  Such  a certain  of market  bond  and does  pays  bonds.  not have  its holders  stock  contracts  features, and  fixed  for  so  instance,  on.  issue  stock  through  arrangement, number purchase  of  a  The  in  a  or any before  fund  a  sinking  fund  Sinking-fund  annual  contractual  contain  certain  a  requirements.  by a  number  redemption  fund  market  purchase In  are  differ  in  fund  this case,  shares a  or  is set  open  of  stocks they  general  amount  is at or below  But  a  sinking  dollar  shares  preferred  features  at a premium, all  of the preferred.  as long as the stock price.  repayment  general  arrangement,  for the price purchase  specific  simplest  a final  include  either  preferred  In  often  issuers to call, and retire, typically  sinking  redeem  an element is  a  characteristics  Preferred  have.  outstanding  Under  the  security,  does.  normally  an  of  a perpetual  is designed to permit  usually to  shares  provision,  each  purchase  also  contracts  portion  purchase  is not lost  a  if a corporation  as a fixed-income  redemption provision  possibility  dividend  as a typical  bond  the  carry  can be paid to the c o m m o n stock.  form,  that  with  issues  words,  stock  payments  stock  In other  the  dividend  preferred  holders  period."  of  any  Most  / 6  from  stipulated thus  very  at  least  Based o n a sample of non-convertible preferred stock issues for the period 1950 to 1965, Fischer and Wilt (1968) report that all preferred stock investigated are cumulative. The cumulative feature is one of the essential elements in building the Heinkel-Zechner model of capital structure choice (1988) which will be discussed in detail later. 4  PREFERRED three is  important  unable  to  aspects. pay  all  payments  would  business's  assets rank  Third, both  there the  on  investor  exclude  up  income.  in  to  tax  contrast, the  first  level  (in  individual  of  the  U.S.).  At  for  percent  event  dividends  of  and  individual  dividends  interest on  the  liquidation. interest  level,  are  corporations  of  on  corporate  7  corporation  claims  dividends  both  and  the  default  the  the  preferred  taxable  85  any  if  bondholders'  preferred  taxpayers  and  omitted  whereas  Second,  but  fully  be  stockholders' in  treatment  is  $100  traditional  thoughts  about  framework  concludes  high-quality  that  index) higher  B.  OMISSION  In  spite  peculiar preferred  preferred  stock  Bildersee (1973) uses an analytical  in a risk-return  with  bankruptcy.  deductible  income  them  preferred  investor  are  of  can  /  not. and  may  at  interest At  the  corporate respectively  income  from  taxable  5  evidence.  stock  forced  tax  and  dividends  portion  differential  interest By  a  the  debt  level,  debtholders.  These  a  preferred  before  corporate  payments  or  result  is  First,  STOCK  of  behave betas)  perform  OF  its  features  more  THE  much of  dividends  like  primarily  emphasized own.  without  market  with  bonds in the  PREFERRED  its  (i.e.  In  penalty  like  further  approach to  by employing the preferreds  are  examine  model  low  market  supported  from  betas  this  to  low-quality  c o m m o n stocks in the  empirical  hybrid  portfolio  relative  while  by  security  theory.  the  He  common  preferreds  (i.e.  market.  DIVIDEND  "hybrid" particular,  nature, that  distinguishes  preferred the  stock  issuing  preferred  does  corporation  stock  from  carry can  bonds.  some omit There  PREFERRED S T O C K has by  been  an  allegation  responsible  when  due.  the  credit  inadequacy would  dividends.  that  by  hypothesis  that  investment  incentives  omission theories  C.  TAX  At  the  of  advanced  corporate earnings.  percent  tax  hold  preferred  dividend  OF  level,  for  firm.  for  preferred  the  risk  of  preferred  the  other  dividends  hand,  some  of  investment  be  discussed used  a  not  may  lead even  the  feature  has  bonds the  to  forced  go  further  preferred  basis for  to  motivation  cash  bring  defer  solution  the  of  and  does  later, forms  have  deteriorating  stock  may  paid  might  prospects  people  funds  as of  distinctive  interest  the  the  adverse  underlying  been  8  regarded  should be  and  preferred  bond  are  dividend  is facing  omitted  be  and  issuing firm  central  to  the many  stock.  STOCK  dividends,  holders,  corporate  dividends corporate is  no  noncorporate  DIVIDEND  like  received. investors such  common  6  This  and  THE  U.S.  dividends,  stockholders deduction  provides  favorable  investors.  IN  preferred  tax  an  a  are  paid  qualify  for  substantially incentive  treatment  Posssibly as  As mentioned earlier, recent changes in the corporate dividend exclusion from 85 percent to 6  interest,  confidence  Regardless  this  preferred  on  bond  dividends  investors'  any  can  PREFERRED  stocks. There  income  pay  need  stock the  For the  rate  in  preferred  deduction tax  On  dividends,  on  TREATMENT  effective  of  preferred  to  in  omission, as will  preferred  after-tax  the  of  the  difference  creditors.  corporations  This type  when  whereas  like  anticipated  weakening  failure  bankruptcy  initiated  argue  the A  an  as  However,  important.  into  bankruptcy  such  purposes, preferred  charges  declare  insolvency,  become  practical  as fixed  to  rating.  and  corporation  and  failure  repercussions  firm's  for  management  A  unfavorable  that,  /  result  U.S. tax code 80 percent.  of  for  out  of  an  85  reduces them  preferred  of have  the  to  stock  differential  reduced  the  PREFERRED S T O C K tax  treatment,  come  from  Brealey  would  PREFERRED  In  the  STOCK  with  in  accounted  most  particularly  stock  from  of  IN  does  a  of  position years  over  about  three  to  others,  noteworthy since  acceptance  of  year  to  only  7.6  Table  is that  lesser the  five  importance  period  percent  percent since  made  II  The ratio in  1982,  to  (1962)  1981.  indicating  the  stock  recent  of other  breakdown  the  of  years, rapid  more  of  l  shows  1987,  the  dollar  the  tax  Sorensen  and  preferred  percent ratio  growth  traditional  preferred  of types  stock  corporate  amount  of  stock  corporate  of preferred that  stock  bonds  (1981)].  offerings  rose  do Also  sharply  for by the introduction and  (expressed  the  of  Hawkins  stock  stock. Within  56  preferred  preferred  advantage  most  that  as a source to  was accounted  a peak  that  of  for the low level  of  preferred  common  In  financing  1968  of  have  and  the volume  reached  at the expense  gives  not  of the growth  stock  in the  Table  does  of floating-rate  preferred year.  percent was  I  1982. The majority  growing ratio  in Table  example,  utilities.  preferred  Donaldson  [see, for  public  is  others,  stock  industry  role  offerings  among  preferred  Mclnish and Puglisi (1980) and  a major  A commonly-used explanation  [see,  of  (1984)].  offered.  stock  buyers  the insurance  securities  that  the  play  of  the  of  THE U.S.  not  exception  in  for only  majority  [see, among  FINANCING  the  was constantly  that  (1982) and McDaniel  U.S., preferred  corporations,  sector  (1984)],  and Hawkins  D.  capital,  expect  the corporate  and Myers  Sorensen  stock  one  / 9  the equity  class itself,  in  percentage)  in  1974  from  and hit a low of  has stabilized floating-rate  at  about  preferred  of preferred  offerings  varied  the  by  20  stock  stock.  utilities  and  PREFERRED  STOCK  /  10  Table 1 Gross  New  Security Issues  in the  U.S., 1968-1987  (in m i l l i o n s  of  U.S.  dollars)  Year  Total  Preferred Stock  Preferred as a Percent of Total  Common Stock  Common as a Percent of Total  Preferred as a Percent of Common  1968 1969 1970 1971  21,966 26,744 38,944 44,914 40,787  637  2.90 2.55 ' 3.57 8.19 8.27  3,946 7,714  17.96 28.84  7,240 9,236 9,689  33,391  3,372 2,253 3,458 2,803 3,916 2,832 3,574  10.1 5.88 6.45 5.24  7,750 3,994  18.59 20.56 23.76 23.21  16.14 8.84 19.20 39.83 34.81  3,631 1,797 5,113 7,213 4,118 6,505 11,514 10,123  4.93 2.55 6.04 6.00 3.11 3.23 3.07  1972 1973 1974 1975 1976 1977  682 1,390 3,679 3,373  38,313 53,619 53,488 53,792 47,230 51,533 73,694 70,441 84,638 120,149 132,531 201,269 374,980 354,700  1978 1979 1980 1981 1982 1983 1984 1985 1986 1987  Federal  Source:  non-utilities.  Reserve  Before  preferred  stock  regulatory  requirements  stock of  is treated  preferred  percent came  offered.  as an  stock  public The  for  sector.  of  in  1982,  1982  over  utilities  imposed  on  to  capital.  70  percent be  utilities started  They  46.70 33.75 49.82 37.63 46.11 21.54 7.63 20.09 16.26 22.25 22.42 22.88 23.42  Manual  may  non-utilities  long-term  period  Industrial  contributed  capital  Since  as a source  the financial  utilities  minimum  the  Moody's  stronghold  equity.  of the total over  from  2.85  Bulletin and  1982,  7,405 8,305 7,861 7,526 7,751 16,858 23,552 25,449 44,366 18,510 29,010 50,316 43,228  7.28 6.00 6.94  43.51 56.41  10.42 13.01 15.53 14.61 15.93 15.04 22.88 33.44 30.07 36.93 13.97 14.41 13.42 12.19  attributed and to  portion  that  increase  comprised  1986. A large  of  more of the  the  total  to  the  preferred the use than  70  increase  PREFERRED S T O C K Table Preferred Stock Offerings by millions of U.S. dollars) Total Preferred Stock Issued  Utilities  1968  637  1969 1970 1971 1972  682 1,390 3,679 3,373 3,372 2,253 3,458 2,803  1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984  3,631 1,797 5,113 7,213 4,118 6,505 11,514  1985 1986  Source:  In  fixed-rate by  preferred  preferreds  industrial  particularly  firms;  stock  in  the U.S., 1968-1986  (in  Non-Utilities as a Percent of Total  481  75.51  156  491 1,243 3,302 2,818  71.99 89.42 89.75 83.55 87.63 86.15 73.83 75.85 53.68 77.05 75.80 65.27 72.57 49.56 29.71 23.99 11.61 14.60  191 147 377  24.49 28.01 10.58 10.25 16.45 12.37  M o o d y ' s P u b l i c Utility  general,  Non-Utilities  Utilities as Non-Utilities a Percent of Total  2,955 1,941 2,552 2,126 2,102 2,182 2,709 3,370 1,304 2,534 2,143 988 755 1,681  3,916 2,832 3,574  11  II  Utilities and  Year  /  312 905 677 1,814  13.85 26.17 24.15 46.32 22.95 24.20 34.73 27.43 50.44  650 865 1,261 493 2,579 5,070 3,130 5,750 9,833  70.29 76.01 88.39 85.40  Manual  financing  are issued  555 417  in  the  by utilities;  and floating-rate  U.S.  convertible  preferreds  banks [Linn and Pinegar (1988)].  has the  are  following  fixed-rate  issued  by  pattern:  preferreds financial  straight  are issued  corporations,  PREFERRED S T O C K E. TYPES OF  PREFERRED  Preferred  stock  or  Fixed-rate  not.  percentage  of  implies,  has  interest  rates.  namely,  the  stock.  are  stock  and  of  par  stock  or  dividend  stated  rate  in  rate  both  interest and  other  there  variants  The  of  of  possess  some  stockholders'  claims  on  assets  stockholders  important causing the  feature  is  and that  issuing firm  to  in  behind omission go  a  as  Despite  elements the  those of  in  of  the  the  variations,  common. always  dividends  its  For  drastic  centers  around  is  7  preferred  different  example, ahead  Another  stock,  of  payout.  the  rank  market  preferred  convertible all  a  name  in  rate  wake  them  as  as  preferred  dividend  such  as  changes  auction  in  bondholders.  preferred  stock,  between  business of  dutch  dividends  expressed  floating-rate  1980s  the  rate  recognize of  well,  fixed-rate  preferred  the  early  stock  of  types  amount  offers  dividend  difference  the  it  to  and  the  stock.  stock  common  stock  preferred  the  two  primary  preferred  has  periodically  resetting  preferred  whether  Floating-rate  are  introduced  method  sinking-fund  value.  preferred  rates.  to  typically  adjusted  Broadly speaking, adjustable  frequency  There  classified according  preferred  were  12  STOCK  be  the  its  They  movements the  can  /  preferred those  common  permissible  types  of but  without  bankrupt.  For the adjustable rate preferred stock, the dividend rate is usually adjusted quarterly in accordance with a specified spread from the maximum current rate of interest paid on short-, intermediate-, or long-term government debt. For the dutch auction rate preferred stock, the dividends are reset every seven weeks by means of the dutch auction process where bids are initiated above the eventual selling price and lowered until the market clears. For a more detailed description of these two types of floating-rate preferred stock, see Winger et al. (1986) and Alderson et al. (1987). 7  III.  The  literature  preferred  stock  financing study  A.  choice. The  is analyzed  texts  conceptual  discussion financing  has or  and  reason  been  acadernic on  without of  two  second for  parts. deals  including  in a corporate  work  omitted  the  into  financing  The  first  with  the  previous  studies  is that  preferred  latter  choice  focuses on  the  subject  on  of  corporate  stock  in  this  context.  STOCK  treatment  finance  is divided  whereas  PREFERRED  Little  be  review  LITERATURE REVIEW  bringing  stock,  the  aspects  valuation.  to  the  literature.  preferred  various its  allotted  subject  Noticeably, the  Most  preferred  in  most  characteristic  corporation of  of  into  preferred empirical  of  that  bankruptcy  stock  such  stock the  as  been  its  work  on  preferred  primarily  on  particular  and  dividends  can  central  the  use  stock  corporate  theoretical  preferred has  in  in  falls  in  corporate into  three  groups: 1.  2.  3.  empirical  examinations  that  focus  stock  issues such as sinking funds or  floating  event  studies  of  on the  preferred  stock,  empirical  investigations  valuation  effects  dividend  capital  features  of  preferred  rates,  structure  decisions that  stock  a  involve  and of  the  use  of  preferred  as  corporate  financing  vehicle.  Donaldson stock  in  (1962) the  discusses  financing  of  the  rationale  industrial  for  the  corporations.  13  use He  of  nonconvertible  hypothesizes  that  preferred  firms  facing  LITERATURE REVIEW / 14 financial  difficulties  deductibility  of  bankruptcy preferred  in  selected  bond the  stock  investigate  on  and the potential  event  a univariate ratios  stock  with  those  They  conclude that  that  and  straight  preferred  preferred  Wilt  stock  stock  place  in the total  convinced as  a  stock  for  the  express a  of  capital  managers in  risk  of  would  make  and Chatfield  (1987)  by comparing  future  tax  nine  preferred  as a signal  stock. to the  rates  or  future  of  long  as  8  view  on  conclude  expense  the  that  as  for the issuing firm and  stock will hold only  a minor  observe that the advantages  liquidity  that  financial  nonconvertible  They  tax, preferred  in periods when  paid  effective  pessimistic  They  the tax  reduced  had issued  financial c o n d i t i o n .  vehicle.  picture.  that  find  had not issued preferred  low  somewhat  income  financing  of financial  use  a  be  may be viewed  expects future  the  Marr,  firms  that  would  hypothesis  industrial  stock  financing  corporate  debt  firm  Moyer,  are not a tax-deductible  can offer  for  25  cannot  distress  of firms  in the firm's  corporate  a majority  substitute  outlook  federal  of  group  issuing  as  dividends  is a high  financial  earnings  Instead,  dividends  alternative.  basis this  the  (1968)  there  a preferred  financing  future  important.  use of preferred  a deterioration  Fischer  longer  for a group  the  negative  preferred  for a control  markets  anticipates  no  that  an attractive  financial  financial  interest  of  is strained  have  apparently  that not  it should be considered continuously plans.  preferred  They stock  finally by  conclude  large  and  that  the  established  O f the nine ratios examined, four are statistically significant and hence support the hypothesis. These four ratios are: (1)market price of c o m m o n stock to b o o k value of c o m m o n stock, (2)earnings before interest and taxes to total interest, (3)retained earnings to total assets, and (4)market value of equity to b o o k value of total debt. Of the remaining five ratios, two have the expected signs but are not statistically significant. These include (1)common equity to total assets and (2)cash flow to total debt. The other three that show opposite signs are: (1)working capital to total assets, (2)earnings before interest and taxes to total assets, and (3)sales to total assets. 8  LITERATURE industrial  firms  assured  of  "sound  is  a  secure  management  With  a  spite  of  view  to  its  model  does  positive relative  are  credit  for  corporate  The  for  Zechner  They  stock  Fooladi  in  the in  and  Canada This  and  issued  their  results  the  by  in  security firms  is  when  corporations  present  preferred preferred  analysis  a  stock. stock.  Their In  is characterized  empirical  evidence  the that  the  United  to  existence  dividend  of  exclusion  a  on  observe  the  the by  Canada, they States  in  simple  and  from  higher  many  for, of  the  States than  industrial  (1986)  feature  examining  United  this  9  demand  taxes,  that  small  Roberts  arrearage  By  appear  of  is  and  of,  personal  investors  the  arrearage  lensen  (1988).  In  their  world  9  debt".  equilibrium.  of  in  Meckling  where  that if  dividends,  issuance of  stock.  stock  work  issuing firm  arsenal  dividend  and  does  financing  supply  incentives  stock  of  Jensen and  argue  the  it  15  create  a  the  dividend  (100  percent)  investors in Canada.  firm, a  tax  individual  importance  theoretical  on  But  preferred  the  preferred  stronger  tax  for  preferred  preferred  the  why  corporate of  one.  disadvantages,  model  both  of  in  rules against  hinge  amount use  positive  not  of  favorable  place  apparent  equilibrium  presence  a  explaining  partial  there  not  REVIEW /  there  preferred cannot  the  draw  issues offered  use  their by  be of  and  Meckling  seminal  paper  (1976)  provide  is  stock put  no  tax  of  into  on  the  advantage  stock a  is  study  stock  Emanuel theory  a rationale  bankruptcy  preferred  preferred  (1976),  possesses all the  conclusion from U.S.  feature  to  for  debt  (1983),  event  justified of  business corporations from  by  1126 1950  found  and  of  ownership  the  use  of  [footnote  characteristics of  in the  is  of its  associated  through  1965.  Heinkel  and  structure  of  of  stock  p.342].  except  nonpayment  nonconvertible  the  preferred  56,  debt  in  They  that  the  preferred  lower preferred  agency stock  LITERATURE costs of and  than  the  associated with  bankruptcy  personal  preferred out,  those  omitted  taxes,  stock  rests  taxes  demonstrate  that  falls  stock  in  problem  their  two-period  opinion  use  stock  survey,  below  preferred  nonconvertible  preferred  order  in  dividends  (1969)  stock stock,  as  to maintain  a balanced capital  2.  to improve  the borrowing  3.  to take  4.  to provide  industries,  nonconvertible  preferred  that  stock  studies  executives'  financing that  instrument.  the four  consider  such  as the  major  on  problem  the  essential  penalty.  1  stated In  0  reasons  reasons for  the  case  of  for its use in  structure,  market  debt  financing,  conditions, and  leverage.  the  varies.  relative  importance  For example,  °This is a survey of 314 issues of preferred stock preferred stock offerings over the period 1945-1965. 1  relies  are  (1988)  overinvestment  conclusion  financial  They  incentives  the  stock  and Zechner  without  a  of favorable  notes  and  base for subsequent future  secondary financial  he  (1977)  points  By introducing  capacity.  investment  their  as he  of  are as follows:  1.  advantage  debt  corporate  preferred level.  can be deferred  he finds  of importance  on  adverse  Again,  model,  Heinkel  a firm's  of  value  for the valuation  arbitrary  debt,  the present  existence  theory  dividends  a certain  use of  Myers  to  The valuation  all  can enhance  model.  Elsaid  of  descending  found  the  a rigorous  that  for the  amounts  Ignoring  framework.  stock as a solution to the firm's  In  Across  debt.  develops  assumption value  preferred  that preferred  the  the  the firm  feature  an  on  The difference  with  (1983)  as an incentive  underinvestment unveiled  Emanuel  primarily  corporate  associated  in a continuous-time  whenever  preferred  costs  debt.  REVIEW / 16  to  of  the  maintain  representing  reasons a  for issuing  balanced a sample  capital of 473  structure favorable  is the most market  important  conditions  reason for utilities.  is  ranked  the  most  LITERATURE  REVIEW / 17  By contrast, to take  advantage of  important  reason  by  manufacturing  concerns.  In the case of  convertible  preferred  stock,  he finds  its use in descending order of importance 1.  to use convertibilty  2.  to improve common  equity  capital  3.  to maintain  4.  to take advantage  Likewise, stock  there  across  indirectly For  worth  major  (sweetener),  base for subsequent future  debt  financing / to raise  indirectly,  are  of favorable  different  industries.  and to  equity  priorities  For electric,  improve  the  of  the  indirectly  conditions.  reasons  gas, and water  borrowing  corporations,  capital  market  base  two  and  to  for  issuing  utilities,  are the two  most use  convertible  to  raise  most  important  convertibility  important  reasons as  and Zechner's (1988)  model  that  preferred  preferred  common  a  are  equity  reasons. to  sweetener.  noting that the survey results are consistent with the theoretical  Heinkel  reasons for  balanced capital structure, and  manufacturing  common  the five  are as follows:  as a selling point  the borrowing  that  raise It  is  implication of  stock can enhance  a trim's  debt  capacity.  On  the  offerings, in  valuation Mikkleson  response  average  effects  to  of  capital  and Partch  the  announcement  (1986)  announcement period  structure  return  find  of  a  the of  changes  induced  marginally offerings.  -0.26%  in  negative They  reponse  by  preferred  stock  document to  price a  preferred  stock effect  two-day stock  LITERATURE offerings.  This  preferred  stock  that  is,  the  examined, return  is  during  find  1.53%  explanations preferred  stock  between  these as  a  two-day  of pure  period  exchange period  offers of  offers  Masulis  not  14  When  insignificant  responses  industrial  of  have  which  which  two-day  given. has  had  of  price  events,  events,  announcement  firms. The  issued  clean  contemporaneous  industrial  been  security  by  average  6  firms  the subsample  contaminated  o n a subsample  offers,  the  (1980)  Masulis (1980)  offers  3.34%  are  whereas  accompanied  are based  by  While  a  the  on a sample  exchange  offers  N o definite authors  reaction  period  and clear  implicitly  lying  is  treat  somewhere  negative  stock  attributes effects,  the  Heinkel  impact  associated  with  their  model's  empirical  opportunity  the  for the issuing  study  by  Linn  market's  the  average  valuation of 47  a of  of  to  price  the  reactions (1988)  the  of  that the  preferred-for-debt  to  announcement  the valuation  sample is far the  suggest  issuance  implication  recognition  a  latter  average  preferred-for-common  announcements, with  significant  two-day  effects  examined  with  by  annoucements  and Zechner  price  with  accompanied  reaction  stock  finds that the announcements of  significant  are  stock  coincides  recent  of  -14.29%.  redistribution  consistent  A  are  Therefore,  common  stock  of  1972-1982.  is  exchange  preferred-for-debt  wealth  that  exchange  return  return  exchange  While  period  hybrid  preferred-for-common  issues.  sample  bonds and c o m m o n stock.  In a study  of  a  a statistically  based  for  on  the  subsample  they  of  based  REVIEW / 18  of  the  of  only  from  the  preferred  issuance  existence  tax and positive stock  of of  nine'  conclusive.  corporate that  effects  is  preferred a  growth  firm.  and  Pinegar  (1988)  examines  the  valuation  effects  of  LITERATURE preferred  stock  reaction issuing  offerings  to  preferred  firm.  Based  straight  straight  preferreds),  adjustable-rate are  issued  straight  argue  are  the  of  and  308  to  the  that,  in  industrial  financial The  They  preferred  general,  firms  corporations  the  regulated  and  their  impact.  Industrial  process.  Any new  prospects. capture  issues  tax  in  differences  are  firms,  two-day  statistically  industrial  the  industry their  anticipated, other  preferred  hand,  stock  positive abnormal  issues  returns  fund  yielding are  for  of  not reveal  (220  for  of  and  by  information  financial issues  period that  return a  of  marginally  Pinegar (1988) offerings Since  is  insignificant  restricted  the  utilities  negative  acquisitions  29  convertible  announcement  stock  the  predominantly  environments.  an  of  and  the  0.178%  19  market  issues  majority  preferreds;  preferred  operating  future  issue  financials. Linn and  responses to  in  of  stock  the  significant  fixed-rate  1.138% for  about  typically on  of  market  information  Finally, the of  level) return  reflect  a  1  issued convertible  differences  groups  1  most  issue  the  preferreds  utilities  issue  that  characteristics  fixed-rate  corresponding  preferreds;  find  industry  registered  convertible  stock;  that  0.10  current,  the  related  observe  stock.  fixed-rate  industrials  (at  that  industry  is  groups.  as follows: an economically insignificant return  for  significant  industry  59  they  stock;  preferred  returns  issues sample  preferred  preferred  -2.015%  a  different  preferreds;  fixed-rate  fixed-rate  stock on  fixed-rate  adjustable-rate  for  REVIEW /  utilities  always  kept  stock  price  any about  result  across  regulatory the  largely  firm's from  benefits.  A l t h o u g h trie average abnormal return of 0.178% for utility issues is statistically significant at the 0.05 level, the authors argue that it is difficult to conclude that this return is economically significant given its size. 1  LITERATURE REVIEW / B.  CORPORATE  There  have  firms'  choice  and  been  Cragg  identify that  FINANCING  the  equity.  optimal  capital  primarily  upon  the  of  firm  these  models  time.  Worse  Their  and  evidence choice  (1982)  Fischer, more  evidence tax  bankruptcy that the  between  firms  also  aims  its  have  and  firms  and  optimal  measure  costs.  a  On  current  and  high  variance  the and  equity.  with  other  of  By  using  for  large the  hand,  expected  argue  Martin  financial multiple  that  an  a firm's  asset  those  value, and  depends  discriminant  ratios. of  mind.  The  are  themselves  One  drawback from  lead  to  optimal  ranges  Scott  bias  to due  ratio  debt  policy.  have  a  asset  (1974)  can also analysis,  a of  time  debt  a small  conditions  on  choice  dynamic  ratio  to  views  in  fluctuates would  debt  from  their  ratios ratios  optimal  is  debt-to-equity  composition.  as  Baxter  aims  instruments  make  ratio which  (1989)  suggests that firms  these  debt  analyse  by  traditional  target to  to  their  issue  the  appear  asset  ratios  appropriate  of  that  and  forward developed  financing  that  debt  Zechner  One  debt-to-equity  indicates  debt  of  put  ones  examine  current  target  risk,  an  to  choice  that  (1982)  and  rate,  firm's debt  firm's  observed  Heinkel,  the  distinguish  between  use  include  that  bankruptcy  relevant  These  choice  (1982).  a  Marsh  financing  Marsh  they  they  of  and  evidence  if  viewing  corporate  low  by size,  still,  (1975),  that  as  is that  empirical  effective  Taub  provide  provided  is a  equity.  difference  evidence  range  and  structure  instrument  "noises".  debt  Marsh  financing  to  models  characteristics  investigations  function  of  1 2  financial  CHOICE  number  between (1970),  issue  Their  a  20  base,  provide  affect they  low  the show  T h e y also include convertible, preferred, and combined issues in their statistical models. The sample consists of 131 debt, 33 equity, 38 convertible, 5 preferred, and 23 c o m b i n e d issues. Because of the small sample size, the parts of their models dealing with the convertible, preferred, and combined issues are far from conclusive. 1  2  LITERATURE that  certain  impact  financial  on  the  companies  are  security (1977), firm's  prices and  choice between heavily in  Marsh  choice of  1.  the  2.  its current  3.  the  conditions  areas debt  influenced  choosing (1982)  and  by  debt  and  provide  its target  as  equity.  market  profitability Finally,  Baxter  evidence  depends on the  debt-to-equity  ratio,  and expected financial conditions, and  prevailing market  conditions.  and  it  conditions  equity.  empirical  financing instrument  deviation from  such  has and  and on  following  liquidity been  the Cragg  this  REVIEW /  an that  history  (1970),  respect. three  have  observed  past  21  In  factors:  of  Taggart brief,  a  IV.  One  of the objectives  firms  that  issue  preferred  examined  is whether  attributes  that saying  do  possess  stock the  or  explanation based  for  dividend  As  the  of  underlying that  other  financial  distress  for  that  types  some  anticipation  of  (referred  as the  to  arrearage  predicts or  firms  future  feature  a firm's  or no growth  of  debt  of  that  to  capacity.  opportunities  up  issuing  funds.  financing,  two  and Heinkel  are  dividends.  to  value  issuing  projects  with  The hypothesis d o not issue  22  that  on  also  preferred  the  differ  in  hypothesis  its  financial by  hypothesis  preferred  NPV's.  incentives to  are  (1988) are  as the issued  increase  positive  first  to the  of cash inadequacy or  primarily  by  about  regard  based  The  (referred is  central  common  the two hypotheses  hypothesis  is  firms  issue  With  The second  stock  issuing  and Zechner  occurs as a result  investment  goes  information  difficulties.  adverse  It  hypotheses  hypotheses  stock  that  be  financial  firms.  stock  provide  of  to  by a set of  firms  can also  of the  hypothesis  preferred  from  preferred  This  financial  preferred  stock  However,  preferred  can  them  these  stock.  factors.  investment  solution  (1962)  dividends  imminent  of  stock  both  passing  related  are defined  as a source  preferred  omission of preferred  hypothesis)  stock  characteristics  foremost  is that  characteristics  below,  and  non-preferred  differentiate  by preferred  motivation  distress  issuing firms  by Donaldson  offered  current  low  of  the financial  first  hypothesis  that  these  choice  the  from  preferred  discussed  experiencing  enhancing  them  of  using  the  Thus,  competing  Some  is to examine  stock  characteristics  flexibility  views  the  preferred  o n the discussions  developed.  the  that  bonds.  motivation  stock.  differentiates  without not  of the study  HYPOTHESES  This  firms claims  stock  hypothesis  hypothesis)  holds  use  means  as  a  in  that of  predicts  that  firms  with  very  stock.  Also  firms  with  very  HYPOTHESES / large  growth  growth  In  opportunities  opportunities  the  follows,  two  different  motives  attributes  of  preferred  although  the  two  stock  dividends,  they  competing  with  other.  of  the  A.  THE  As  firms  on  earnings such  a  meeting  is  firms  in  preferred  to  The  terms.  performance  and  happens,  contractual  issued stock  the  developed  stock.  The  it  It  motivations mutually  moderate  explain  to  is worth for  the  possible on  the  noting  that  omission  and  separate  the  as  predictions  exclusive  is difficult  completely  literature  funds  reasonable  with  thus  one  observed  of not  from  the  characteristics  stock.  It the  obligations.  been  selling usually  like  firm  firms  that  may It  facing  cash  leads  the  have  to  at  in  to  that  financial  servicing  forgo  He  that  made  this  popularity the  a good  inadequacy  difficulty  in  recognizes  stock  firm  hypothesizes  distress.  substantially  hypothesis  the  (1962)  financial  common  have may  Donaldson  declining  distress  by is  review,  by  had  financial  raise  different  this,  firms  HYPOTHESIS  the  primarily  can  are  also presented.  necessarily  Because of  but  3  hypotheses  are  on  not  DISTRESS  funds.  state  rely  are  1  stock,  issuing preferred  issuing firms  hypotheses  earlier  when  of  distressed debt  these  stock  hypothesis  for  that issue preferred  mentioned  source  each  FINANCIAL  preferred  the  hypotheses  preferred  of  preferred  which  of  None  issue  stock.  explanations  other.  not  use preferred  analysis  do  do  23  inability  price arises  of  from  poor When  payments  positive-NPV  a  or issuing  difficulties.  debt  as  projects  and or  It should be noted that the logit analysis used in this study does not deal with the prediction that the use of preferred stock is to enhance the firm's debt capacity. In addition, it only serves as an "indirect" test of the prediciton on the relationship between the firm's preferred-to-stock ratio and its growth opportunities. 1  3  HYPOTHESES / disinvest  to  problems distress  fund  can  simply  occurs.  tax  advantage  All  these  the  debt  why  cannot  does  financing? number  traded  to  the  firm.  appealing  problem  but  not  short  its  firm when  stock  a  event  has  of  time.  terms  advantages point such  of  the  point  of  given  of of  investors The  senior  liquidation. control on rise to  view,  which  more to hold  active  Preferred stocks,  not  end  preferred  its financial  financial  financing  stock  the  stock do  effective Dividend it  assets  like  to  management Rollover  preferred  or  prices  to  be  a  may costly  is  more  common  would  create  happen. of  of  has  stock  offerings  not  source  would  preferred firm's  a  stock  offerings  stock  distress,  stock  common  in  obligations.  common First,  the  earnings.  as  firms  be  of  would  is in  utilize  stock  on  and  level  these  financial  common  common  some  if  fully  Thus,  firm  investors,  claims  Third,  firm out.  the  common of  cannot  meeting  stock,  dividends  lower  the  when  view  the  dividends  over  preferred  firm  of  as  circumstances. that  are  the  has problems  such  given  1 0  it  of  preferred  because  preferred  state  emphasis  corporate  period  under  use  the  attractive  reasonable have  from  holders  the  the  practitioner's  dilution  years  pay  issued on  the  of  least,  encourage  the  depressed  in  the  recent  to  Second,  as  stockholders  in  a  more  to  the  chances that  financing  stock  shortcomings in  debt  With  suspending  also'. greater  fail  be  From  by  it  preferred  of  be  are  preferred  should  payments.  avoided  accompanying  provides flexibility  If  be  There  make  bankruptcy  interest  24  idle  Last cash  programs  which  common,  for  a  associated risk is correspondingly reduced.  "Preferred Dividend Rollover is a cash management investment strategy designed to take advantage of the 85 percent (or more accurately 80 percent), dividend exclusion on stock held by corporation. In Preferred Dividend Rollovers, the corporate cash manager engages in an active trading strategy designed to acquire preferred stock shortly before the ex-dividend date and sell it on or after the ex-dividend date, and continually roll over the proceeds into other preferred stocks about to go ex-dividend. 1  HYPOTHESES / From  a  stock  is  theoretical consistent  Narayanan internal  (1988).  sources  of  pecking  order when  attractive,  it would  does firm  distress  has  debt  have low  help  the  problem  have  B.  THE  SOLUTION  In  contrast  to  the  of  of  to  the of  common risk,  likely  firm. the  stock  lower to  preferred preferred  firms  tend  risky  securities  financing  stock  before  be  a  to  behavior  the  good  bankruptcy  to  external follow  of  debt  to  for  debt,  facing  preferred  stock  expected  earnings,  the  C o m p a r e d to  common  stock, preferred  at  shareholders  strain  dividends  enables  tax  the this  liquidity,  INCENTIVES  lays go  in  In  sour.  When  the  advantage  of  firm  and  view,  and  stock avoid  firms  low  that  effective  stock.  financial  hypothesis  over  a depressed price.  less  firms  turn  existing  a  resort.  things  and  if  if  on  stock.  candidate  Compared  and  rely  a , last  issuance  common  to  tends as  common  (1984),  equity  considered  finds  INVESTMENT  stock  that  profitability,  traditional  incentives  suggest  firm  issue preferred  ADVERSE  over  Majluf  always  to  stock  and  funds.  forced current  control  more  having  feature  of  negative  TO  investment  motivation arrearage  more  external  preferred Myers  less  is  hypothesized  problem  the  equity  for  (1984),  corporate  preferred  requiring  bankruptcy are  prefer  distressed  to  is  Myers authors  words,  turn  selling  tax  adverse  first  even  income  to  common  unimportant  of  and  preference  by  these  financially  the  the  work  other  stock  preserve  higher  In  and  or  becomes  can  the  a  preferred  not  with  where  Therefore,  financial  view,  funds,  is sought.  sum,  of  Specifically,  financing  In  point  25  distress much into  the  HYPOTHESIS  hypothesis,  of  its  arrears.  firm  not  the  ground It  to  is pay  solution  on  a  assumed out  the  to  different that  the  preferred  HYPOTHESES / dividend  but  empirical  implications  Zechner  incentive  of  suboptimal does  the  prefer  borrowing  base?  for  stock  to.  If  be fund  offset  firm,  stock  debt  lucrative  to  can  be  the  stock  the  means to  rather  an  to  caused  make  asymmetric  help  or  the  But  stock to also  why  improve  create  suspend  an  common  reason  that  preferred  incentive  than  common  debt  financing.  In  incentives hypothesis claims that the  debt  eliminate debt.  can  (1988)  stock and omitting  financed  overinvestment  additional  cut  by  and  additional  The  can  overinvestment  the  Heinkel  all-equity  common  to  on  previously-issued senior  stock  Zechner  incentive  adverse investment  than  by  an  problem.  common  and  create  using preferred  firm  flexibility  flexibility  Heinkel  that  issuance of  preferred ' stock,  purpose.  the  based  incorporates  solved with  dividend  allow  carries  that  argue  leads  is  developed  underinvestment its  preferred  hypothesis  model They  however,  underinvestment  investment  opportunities growth  the  that  and  and  efficient  increased by  a number  firm's  Like  solution to  preferred  use  investment  is a more  the  to  quality.  (1977)  due  behavior  incentive  stock  terms,  stock  investment firm  dividends  debt,  The model  two-period  problem  to  project.  structure  project  cause Myers'  preferred  overinvestment  to  a  investment  would  risky  consider  advantage  that  a  capital  The  tax  in  the  overinvestment  issues  can  of  who  about  it  has an  debt.  its  invest  (1988),  information firm  to  26  preferred  specific  firm  value  dividends  later  projects.  does  of  empirical  capacity. and  a  do  firm's not  projects.  role  in  solving the  implications follow.  Second,  the  opportunities investment  play  there  is  a  Without  new  First,  negative  preferred-to-debt issue preferred  adverse incentive  ratio.  stock  at  profitable  preferred  stock  relationship Firms  problem  with  very the large  the  enhance  between  all because of investments,  can  of  low  a  growth or  no  absence of scale  debt  HYPOTHESES / financing is  is less  remote.  with  very  results  probable  The  incentive  large  growth  from  the  preferred-to-debt growth  and for  opportunities  further  that  have  growth  Myers  (1977),  with to  underlying  debt.  raise  who  for  a firm  has  an  optimal  debt  vis-a-vis preferred  from  an  inverse  and  Zechner  the  need  growth  At  raise  offset  stock when  it  between  equation outside  22].  negative  less  capital,  ratio  words,  the  a  and  the  use  of  it  easier and  of  firms  preferred from  opportunities less costly  stock would  incentive of  is more  likely  to  sell  issue  This follows  opportunity  will  lose  debt.  opportunity.  firm  Heinkel  developed  growth  growth  moderate  ratios.  fund  it  growth the  This  classes  be  preferred  mind,  and  maintain  can  find  issued,  stock.  with  two  extensive  to  potential  a higher  other to  are  underinvestment  has the  utilities make  in  Firms  preferred-to-debt  difficult  ratio  preferred  22].  problem  reduced. Firms  opportunities  relationship  debt  the  In  growth  thus  growth  no  [equation  is rather  large  or  highest  and  underinvestment  [Heinkel  bonds,  lower  preferred-to-debt  reality  of  given  ratio  if  opportunities rise.  first  blush,  preferred argues  to  it  little  banks and  preferred-to-debt  relationship  (1988),  the  an  stock is therefore  between  have  this  having  have  paper  securities. With  its attractiveness as a means to  If  will  their  that  firms with  of  preferred  opportunities  points out  debt-like  of  suggest that  intuition  Therefore,  less  in  therefore  Zechner (1988)  An  use  relationship  derived will  moderate  likelihood  opportunities  and  stock.  the  inverse  ratio  the  27  one  dividends  that  commitments  might are  used  management to  throw  preferred  in  as  doubt a  normal  source  on of  the  financing.  circumstances  shareholders and  failure  feels to  do  the  Although  obliged so  to  would  assumption Emanuel honor  that  (1983)  dividend  deteriorate  the  HYPOTHESES / firm's  creditworthiness  capital firm  in  does  equivalent securities.  the not to  which  marketplace, have  to  investing),  H e n c e , the  would omitting  sell  off  or  that  hamper preferred  assets it  future  has  assumption is valid  to a  attempts  dividends  fund  the  cheaper  in this  by  essentially  dividend source  regard.  the  of  firm  means  payments funds  to  issue  that (which  than  28  the is  issuing  V.  One  of  the  attributes  objectives  that  preferred  this  instead  the  of  previous factors  leading  developed  by  Baxter  and  a  meet  firm  requiring  stock,  ratio firm  and  is above would  where  accept  temporary  the  tend  to  targets  costs  of  find  the  and the  stock  the  lead  of  bonds.  on of  by the make  debt  meaning  wide of  are  from  cost of  infrequent time.  The  swings  optimal  in  debt  ratio  and  of  firm's and  debt new  (1989)  find  is that  the  ratios  equity  small  any debt  They ratio  can  if  the  its  costs,  forced  in to  costs  reason that  fluctuating  even  that  is  this  to  time.  it  However,  transaction  related  argue  the  bonds, issuing  firm  is for  over  to  models  transaction  It  ratio  29  no  the  debt  study  issue,  issue  until  debt  the  the  continuously.  issue.  will issue  (1982),  capital  With  ratio  fluctuation  boundaries is optimal.  Of  of  used in this study.  a  significant,  set  choice  Marsh  should  and  issues with their  Zechner  a  firm  otherwise.  optimal  degree and  The  making the  lumpy  model  make  instantaneously  its  not  to  end,  financing  and  a  firm  include selling long-term  debt  present  this  stock.  (1975),  decided  equity.  issue  ratio  costs  Fischer, Heinkel, to  and  To  preferred  the  between  that the  corporate  Taub  ways. These  common  target its  has  relationship  probability  or  choice  (1970),  finance  divergence  over  adjustment.  its  transaction  outweighed  firms  the  new  offering  adjust  reality  are  to  used by Marsh (1982) comes closest to  preferred  the  to  METHOLODGY  models  Cragg  its needs in a number  debt  is  empirical  the  When  study  common  investigate  framework  AND  describes an individual firm  stock  synthesizes  of  MODEL  around  costs  of  recapitalization  therefore  lying within  refine a set  MODEL For  simplicity,  stock,  preferred  new  finance  issues  assumed  are  have  mutually  more  function  expected m  Suppose  i  of  a  exclusive. one  firm's  deviation  of  to  issue  to  raise  Z  j t  Z.^ : the  decision to of  bonds  (3)the  =  in the  ,•)  =  prevailing  long-term  hypothesized  debt  capital  ratio, market  The  functional  (2)its  conditions. (m = 3  in  form  of  firm  i  c o m m o n stock at time  t,  F. ,  f  M.  t  choice  t  of  t,  D.^ : the  actual debt-to-equity  ratio  of  i at time  t,  F.. it  : the  set of  financial conditions of  i at time  t, '  M.j. : the  set of  market  or  equity  tend  to  occur  firm firm  conditions facing firm  security at  stock,  ith  among  i at time  of  case).  firm's  )  of firm  type  and  way:  ratio  one  our  the  to  Denote  2=common  target debt-to-equity  any  is,  period  current  : the  issue  that  is  1=bonds,  financing  stock, and  issues,  instrument  (j = 1,2,3;  - D;  requiring  particular  j  t  firm  a  available  D.  30  common  in  instruments  following  «  /  the analysis.  target  capital.  namely,  multiple  offered  financing its  security  external  preferred D.  from  alternatives,  words,  security  of  METHOLODCY  choice set facing the  other  of  financing  t can be written  where  sales  financing  In  type  choice  types  decides  Prob(  The  three  constitute the  conditions, and  stock)  at time  than  (1)the  number  firm  3 = preferred choice  of  financial  the  the  in our study), are excluded from  previously discussed, a  that  stock, and bonds,  fiscal year  be  by  is  and  which  (one  As  it  AND  is  discrete  i at  time  characterized  by  intervals  in  and  debt,  and t.  the  fact  relatively  that large  MODEL amounts.  Because  financing,  firms  ratios. the  The  of  planning  nature  analysis  the  of  logit  subsection  to  new  this  justify  multinomial  costs  the  of  issues  use  a  would  and  of  a  general  the  discrete  model  the  description  as  model.  corporate  and  use  well  exclusion of  choice  a firm's  METHOLODGY  infrequent  consider future  decision-making and  is employed to  follow,  adjustment  AND  as  of  /  31  external  current  debt  multiple  issues  from  In  study,  this  financing behavior.  specification  of  the  the  In  the  model  are  presented.  A. THE  The to  MULTINOMIAL  multinomial analyze  Another are  logit  commonly  they  1 5  is  qualitative  based on  terms,  LOGIT  statistically  one  different usually  (1981),  computational  cost.  corporate  model  give  advantage  the  the  two  is  the  similar  Because  of  the this,  widely  which  take  multinomial the  results  p.1502].  over  most  variables  assumptions about  computational  analyze  of  dependent  used  [Amemiya  MODEL  the  and  However,  the  multinomial  on  probit.  discrete more  While  distributions it  multinomial  used  is  difficult  multinomial probit logit  and is  of  choice  than  two  values.  these  two  models  their  to  random  distinguish  logit  model  involves  used  models  in  this  error them  offers  much study  a  less to  financing choice behavior.  Both the multinomial logit and multinomial probit are derived from the random utility model in which the utility of an alternative to an individual is specified as a linear function of the characteristics of the individual and the attributes of the alternative, plus an error term. The probability that a particular individual will choose a particular alternative is given by the probability that the utility of that alternative to the individual is greater than the utility to that individual of all other available alternatives. If the random error terms are assumed to be independently and identically distributed as a Weibull distribution, the multinomial logit model results. If the random error terms are assumed to be distributed multivariate-normally, the multinomial probit model results. 1  5  MODEL The is  model faced  specification of the multinomial with  probabilities choosing  an  m  mutually  associated  and  j  =  these  Let  alternatives. by  the  P^,  32  Suppose an individual P^,  Suppose  individual  /  P  the  depends  be  the  probability  for  on  m  a  vector  of  x as follows:  expt/3'.x] / D  p\ is a column vector  D is such  is as follows.  alternatives.  m  (j = 1,2,...,m)  attributes  P.(x)  where  with  alternative  individual-specific  exclusive  logit  AND METHOLODCY  (j = 1,2,...,m)  of unknown  parameters;  that  m I  and  hence  P.(x)  j  '  D  =  =  m E  1  exp[p".x]  j  Evidently,  p\'s are  of  without  (i.e.  them  not  '  identifiable  affecting  the  since  any arbitrary  probabilities  m is chosen as the base alternative).  at  With  vectors  all. This  may be  requires  the above  added  normalizing  normalization  to all 0  =  u  m  =0),  (3 m  P  (x) =  1  / D  since  exp[/3 '  x] =  1.  (for the base alternative  m)  MODEL B.  THE  In  our  LOGIT  case  alternatives include of  of  bonds,  analysis  model  OF  firm  the  of  it  with  (D  and  as  (2)  column  D  was  vector  defined of firm  pertaining  to  alternative  and  Z  i  choosing preferred  at  there  external  long-term  to  Prob(  the  time  common in  (j = 1)  =  j t  Z. it  =  on  =  )  independent  j.  Expressed  in  the  stock  as the  e x p [ / 3  i it x  ]  of  33  (i.e.  directly.  /  (j = 2)  at  These  is the  focus  such  that  Following  probability  that  time t is  D  (j = 1,2)  (j = m)  is  D  with  of  stock  made  exclusive  financing.  alternative  (m = 3)  m = 3. (i.e.  The  odd divide  ratio (1)  vector  firm-specific  corresponding  form  denominator  be  variables  the  base  stock  1 /  subsection  source  stock  jt  =  mutually  subsection, the  exp[^jx ]  preferred  m  m= 3  the  can  common  is  =  stock  or  p\  W  as  previous  and  1  it  are  As preferred  the  j )  previous  t  stock.  have  i will choose  observations  to  W  =  in  pertaining  of  and  Prob(  that firm  P (x.J m it  where  natural  METHOLODGY /  CHOICE  choice,  preferred  described  =  jt  probability  is  issue bonds  P.(x )  the  it  and  bonds  specification  firm i will choose to  requires  stock,  paper,  FINANCING  financing  i which  common  in  CORPORATE  corporate  facing  comparisons the  MODEL  AND  vector with by  x.^  is  the  attributes)  of  coefficients  the  probability  (2)),  MODEL P (x ) 2  Taking logarithms  (3)  / P (x )  jt  3  o n both  =  jt  sides,  Log[  P^x. )  Logt  P (x ) /  / 34  exp[B'x. ] t  the expressions become  I P (x. ) ] =  A  AND METHOLODCY  3  t  Log[ P (x. ) ] - Logt P ( x ) ] n  t  3  jt  and  (4)  where  subscripts 1,  respectively. (j = 1,2)  It of  2  2,  Therefore,  verified  the l o g - o d d  and 3 p\  ratio,  vector  likelihood. alternative the  of  j at time ith  firm  2  jt  bonds, c o m m o n as the  y..^  and (4)  p\, a  that the logit  can  be  with  m= 3  sample is  t i j  y.. p.(x ) 'J* 1  1 1  estimated  variable  and 0 otherwise.  nn n  in  P (x ) ] 3  jt  and preferred favor  coefficient,  of  stock  alternative  j  j3., is the  derivative  variable.  Thus, the  respect to the independent  dummy  n n m m  stock,  odds  with respect to an independent  is faced  L =  Log[ P ( x ) ] - Logt  j = 3.  m  t  =  expressed  l o g [ P . / P l , with  by  ]  represent  (3)  coefficients,  Denote  jt  can be  from  elasticity of the o d d ratio  Since  3  over the base alternative  is directly  The  P (x )  jt  which  Let there  by  variable  the  equals  is jS.x.^.  method 1  if  of  firm  maximum i  chooses  be n observations in the sample.  alternatives,  the  likelihood  function  of  the  MODEL Hence,  the  METHOLODGY  /  35  log-likelihood function is  n log  L =  Maximization  of  of  attractive large  the  p\.  above  This  sample  m  L L L t  estimates  AND  i  j  y  log[ '  log-likelihood  method properties  function  guarantees for the  P (x ) ] '  will  consistent  produce parameter  sample statistics.  maximum estimates  likelihood and  the  VI.  The  corporate  stock the  behavior  has just  empirical  been  this  have  coming  up  variables  the  with  highly  the  multivariate  The  candidate  to  the  be  and  are  and  among  bonds,  preferred  stock,  modeled. This section turns presentation  used  be  for  in  the  of variables  the  of  logit  in  use  constructed  reduction  significant  in  important  variables  first  the  to  to  be  and  the  common  description  of  used.  previous  in  for  regressions  the  logit  univariate  multicollinearity,  univariate  analysis  are  related model,  empirical a  analysis. only  are  selected  broad  For  those  included  studies. list  the  the  of  sake  candidate in  because  they  Before  candidate of  model  variables  final  model  that for  analysis.  variables fall  1.  deviation  2.  determinants  3.  the  firm's  4.  the  market  It  variables  claimed  will  simplicity  discussed  SPECIFICATIONS  PROCEDURES  study,  been  choosing  procedures and the  A. EMPIRICAL  In  in  EMPIRICAL  from of  the the  financial  into  target  four ratio,  optimal  broad  categories:  ( D - D  target  debt  ), ratio,  *  R ,  conditions, F, and  conditions,  M.  is assumed that  *  R =  f(firm  size,  asset  36  composition,  bankruptcy  risk,  growth  EMPIRICAL SPECIFICATIONS /  F  =  M  FROM  The  from  between firms  the  with  whereas debt.  preference  a  in  issue  target  time  of  may  securities departures  to  the  simply  firm's  from  ten-year  and  investment  as a  stock  if  ratio  whole).  nature on  misleading. market  Finally, the  the  with  target  years  use  after-issue to  the  before  This historical estimate  book  itself  equity to  regard  ten  issues  conditions  that  stock is considered as  a crude  Second,  issue  affect  firm.  the  to  will  the  new  is expected  prone  made  of  difference  more  the  provides  the  are  over  of  It  likely  preferred  ratios  earnings  favorable  target.  stock  debt  more  is  as  (DEV).  targets  prediction  lumpy of  are  the  defined  value  common  only  estimate of  or  target  out,  retentions  long-run  targets  no  actual  discrete of  the  common  points  advantage  the  and  the  (1982) the  take  from  of  measure  the  is  its target  preferred  direction,  average  make  on  and  deviations  preferred  effect  return  ratio  ratio from  either  same  as Marsh  issues,  debt  debt  deviations  the  semi-automatic  target  sale  First,  new  and  THE TARGET RATIO  negative  The  level.  of  with  is used to  however,  liquidity),  current  between  equity.  [(profitability,  the  positive  Since  deviation  an  firm's  firms  tax),  = fflevel  B. DEVIATION  deviation  opportunties,  37  of  average,  the  coupled  value  debt  the  actual  with ratio  the over  the  tendency  of  may  result  temporary  may  have  in  selling  changed over  time.  An  accompanying  book values rather  problem than  with  market  the  measurement  values. While  the  of  the  theory  debt of  ratio  capital  is  the  use  of  structure suggests  EMPIRICAL the  use of  the  use  values,  book  values.  of  measured used  market  in book  value  by corporate  that  corporate  He  further only  value  of  future  evidence  that  the  to  ratios.  Because  its hybrid  of  sometimes  preferred  management  debt  other  hand,  capacity, grounds,  as  with  be  point  sinking  suggested stock  stock by  fund  of  view  or call a  other  is arbitrarily  do  of  as  treated  it  authors not  use  of  Because  values.  that  book  the  present  later  book  provide  value  target  in obtaining  market  debt-to-equity  been Marsh  is such  treated  normally  as  equity  regarded  as Bradley, preferred  is a debt-like  equity  cushion  both  reasons in this  ratio.  (1982) argues that  stockholders,  as an equity  al. (1973)  study.  include  common  layer  (1988)  of the firm's  provisions,  utilities.  for  be  those  market  account  in this  ratio.  et  view  has sometimes  debt  (1988)  provides the  as  some  and Wessels  the  ratios  of the debt  classified  However,  fact  should  (1977)  Wessels  / 38  prescribe  closely with  than  and the difficulty  value  stock  rather  not  in  ratio  more  Myers'  and  the definition  preferred  debt  texts  by Stonehill  book  do  do  reasons  in the computation  preferred  preferred  Titman firms  to  of  but  the  study  with  place  finance  accord  a survey  values  in  many  come  nature,  should  From  that  already  that  ratios  in terms  we use book  we  and Titman  category.  particularly  debt  value  book  managerial  argues  He cites  of  that  as a debt.  (.1984)  as book  Because of these  when  stock  (1982)  opportunities.  especially for debt,  arise  Kim  assets  and many  to think  use  growth  Ambiguities  and  tend  suggests  debt-to-equity values,  terms  treasurers  refer  Marsh  managements.  justifies  values  accounting  SPECIFICATIONS  Jarrell, and  stock  in the  preferred security. to  stock, O n the  increase  have  study.  1  by  their  debt own  6  Redefining the debt-equity ratio as the ratio of long-term debt plus preferred stock to c o m m o n equity (i.e. preferred stock is viewed as similar to debt) makes little difference to the results. 1  6  EMPIRICAL SPECIFICATIONS /  39  C. DETERMINANTS OF THE OPTIMAL DEBT RATIO  Different  theories  number are  of  of  capital  attributes  denoted  firm  that  size,  structure  may  asset  affect  (both the  static  firm's  and  optimal  composition, bankruptcy  dynamic) debt  risk,  have  target.  growth  suggested  These  a  attributes  opportunities,  and  tax.  1.  Firm  It  is  Size  well  Cragg  known  (1970),  that  Martin  the  and  firms  are  more  likely  stock  is  more  attractive  against small  issuance firms  tend  account  for  attribute  this  capital in  enjoy  difficulty also  a  to  use  the  It  to  to  firm  with  long-term  Fischer and  Wilt  the  short-term  of  and  constitute  as  size  than  relationship  is also argued that firms with  larger  evidence  sound  and  Wessels  debt and  than large  firms  a  assets tend  authors  do.  access  to  usually  Merville they  and  size.  direct  value  as  be  more  To  the  found (1972),  have less  Bankruptcy  that  to  that  most  and  firm's  find  firms,  leverage  evidence  rules  do.  financing media,  small  preferred  firms  are  Logue  small  large  firms  of  that  (1988)  As larger by  and  management  of  provide  Baxter  (1968) suggest that  between  proportion  size.  ease  potential  issues  its  a firm's  indicated  respect to  larger  on  costs.  M c C o n e l l (1982) a  small  to  provide  when  Titman  between  impact  positive  firms  and  more  debt  related  (1975)  (1982)  industries,  is  and Taub  industrial  difference the  a  associated flotation  scope  A n g , Chua,  small  Marsh  mature  in  (1974),  significantly  effect  more  role  appear  to  debt.  and  of  issue equity.  of  marketing  and  decreases.  to  a greater  in  play  (1977) costs  and  Scott  observed  size  markets  older  and  the  leverage  costs Warner  bankruptcy that  value  diversified  EMPIRICAL SPECIFICATIONS / 40 and  less prone  on to  t o bankruptcy.  in case of adversity. the costs  with  higher  of recapitalization.  ratio. As small  firms  are expected  debt  after  highly  less  clearcut.  indifferent  The  larger  to have  variable  theoretical  (SIZE1)  transformation  and  for this the  reflects the view  ratio  ground,  of firm  of debt  we  range and a lower  debt  costs  ratios  stock  assume  size is related firms  than  larger  and a lower  suggest  preferred  back  show that  transactions  arguments  between  that  larger  firms  optimal  firms are  and c o m m o n  that  firms,  stock is  are  somewhat  stock and c o m m o n stock.  attribute  natural  debt  range  All these  The choice  Without  a larger  a wide  resources to fall  and Zechner (1989)  proportional  with the use of preferred  indicator  assets  have  greater  of the impact  Fischer, Heinkel,  recapitalization.  leveraged.  may have  interpretation  costs  incur  small firms  more  Another  recapitalization  ratio  Larger frims  is proxied  logarithm  that firm  by the natural  of  sales  size affects  logarithm  (SIZE2).  mainly  The  the very  of total  logarithmic  small firms.  2. Asset Composition  The  distribution  structure  choice.  evidence  that  to  have  a  recapitalization. leverage debt  of assets  owned  A recent  study  firms  with  wider A  a higher  debt higher  and in turn  ratio  by a firm by Fischer, variance range  composition  a higher  issue should be negatively  variance related  may in some Heinkel,  of their and a  of  fixed  and Zechner  underlying lower  assets  of asset value.  way affect  (1989)  provides  assets are more  optimal implies  Therefore,  to the proportion  its capital  debt a  higher  ratio  after  operating  the likelihood  of fixed assets.  likely  of a  EMPIRICAL As  to  has It  the  been  choice advanced  is therefore  common  The  stock  figures  of  Zechner debt  (1989)  debt  Two  of  on a firm's  a prediction  no  theory  asset composition.  o n the choice  is taken  as the  ratio  of  between  fixed  to  total  assets  (ASSCOM). •  show  that  increase  firms  firms  increasing  with  with  debt  The first  and Turnbull  fixed  risk  ratio  variable  standard  risk  operating  risk  is the  it  tradeoff  debt.  costs  makes  of which  of operating  of  bankruptcy  costs  and  costs.  optimal  risk.  The  its determinants experimented "bankruptcy  o n average, For to  before  deviation  (past  interest  levels  of  the  initial  principally  of  two  former  is  customarily  are our concern (1982)  measure  and tax (EBIT)  ten years)  low  higher  lower  in Marsh  risk"  that  Fischer, Heinkel, and  have,  consists  suggests  namely,  charges - earnings  estimated  high  Bankruptcy  risk  (1974) (RISK1),  the level  low bankruptcy  bankruptcy  financial  measures  with  very  recapitalization.  namely,  of the four  tax-advantage-and-bankruptcy-costs  bankruptcy  by the firm's  our model.  White  of  after  components, measured  view  costs,  ratio  virtually  stock.  composition  range than  bankruptcy  conditional  stock,  Risk  costs  ratio  and preferred  not to include  net of depreciation)  traditional  expected  in  asset  stock  the choice  appropriate  and preferred  3. Bankruptcy  The  common  to predict  more  measure  (both  between  SPECIFICATIONS / 41  of earnings  here.  are used  developed by  EMPIRICAL SPECIFICATIONS / The  order  different an  which  from  the  advantage  words, the  the  firm.  Capron scaling third  larger  the  The  is  value risk  total  which  deviation  expectd  of  is  of  that  of  risk  likelihood  is  of  deviation  of  debt  is  is  from  EBIT has  proxies  used.  In  bankruptcy  Brealey, scaled  risk  and  income  negatively  other risk  Hodges,  EBIT,  two  (1988)  operating  numerator  deducted  these  Wessels  the  is the  from  in  issuing  larger  with  in  risk  taken  and  change  be  other  Along  Titman  percentage  arranged  the  standard  (R1SK2).  from  the  proxy,  which  the  is  charges should  sign with  the  by  taken  the  fixed  assets  the  expression  variable,  measured the  that  alignment  second  is  variable,  difference  convention same  factor  is  the  of  (1976),  standard It  in  42  of and  where  the  measures,  defined  (RISK3), related  as  a the  is added.  to  the  risk  risk  are  stock  and  variables.  If  the  financial  expected bonds. odds by  to  going  issuing  due  to  help  a  under.  Although  stock,  financial  account  for  first,  then  then  perhaps  finds  it  theory  equity  costly to  for  only  the  holds,  use  aggravate  these firm  holds  hybrid as  might  that,  if  a  last  such  resort.  due  to  the  stock  c o m m o n stock.  to  both  bankruptcy common  situations  accept  a  rather  than  is  when  a  increasing risk of  can  be  the  avoided  stock  price  order  theory  may  common  stock.  The  issue  debt  required, bonds  increase  depressed  pecking  convertible  and  bankruptcy  (1984)  finance  Therefore,  the  over  costs of  Myers'  as  higher  financial  have  external  with  stock  increased  preferred  securities  issue debt  stock before  of  firms  preferred  distress. Alternatively,  the  possibly  preferred  preference would  common  order  hypothesis  bonds  the  pecking  to  have  Issuing of  distress  firms  and  preferred  financially bankruptcy,  stock,  distressed  firm  it would  turn  EMPIRICAL SPECIFICATIONS / 43 4. Growth  In  Opportunities  an agency  (1977) debt  shows  be  difficult,  not  debt  growth  negative  When with of  expect  common  stock  higher  growth  preferred  stock  the  words,  firm  opportunities  firm's  growth  to  an  issue  come  are more  likely  with  the  into  debt  and  play,  to  thus  is therefore  very  a negative  relation  preferred  opportunities in  it  growth retire  stock find a  and  its  opportunities,  preferred  is expected  adverse  with  and  and Zechner (1988)  to use c o m m o n  solution  Myers  opportunities  between  increase debt  contracts,  intangible  expect  relationship  stock  is not in line  would  Heinkel  given  are  with  forward.  of  growth  opportunites  The  tends  and preferred  fund  opportunities  the  other  as nexuses  to  reasons, we  is less straight  In  firms  growth  opportunities.  between  that  for  that  For these  growth  ratio.  are viewed  Financing growth  impossible.  relationship  firms  difficult  argue  opportunities  would  where  is more  Others  and  preferred-to-debt we  it  collateralized.  if  between  context  that  borrowings.  cannot  and  cost  that  stock. firms  stock as the issue investment  incentive  hypothesis.  The  proxies  measured between (GROW2).  by  for growth the  opportunities,  percentage  the market  value  change  albeit in  and book value  imperfect,  total  assets  include  the  (GROW1)  of c o m m o n equity  growth  and  the  of assets difference  scaled by total assets  EMPIRICAL SPECIFICATIONS / 44  5. Tax  In the theory of optimal capital structure, tax provides an incentive for the use of debt  by generating  tax shields.  increase  in the use of debt.  analyses  due mainly  statutory  tax rates for the past  Raising  corporate  However,  to the fact  that  few studies  there  couple  tax rate  have  have  been  should  result  included  virtually  of decades or so. Taub  in an  tax in their  no variation in (1975) reports a  significantly negative relation between statutory tax rate and the firm's debt-to-equity ratio. This is contrary to the theory some  unknown  and Taub  factors that are closely  (1975) ascribes the wrong  correlated  sign to  to the tax rate as well as  the  small variation in tax rate over his period of study.  In fact, most statutory face  the  and effective  the same  widely  researchers have overlooked  the discrepancy  tax rates for debt  statutory corporate  finance. In the U.S., most  tax rate  but their  across industries and firms. Cordes and Sheffrin  effective  tax value  significant variation  of incremental  that exists between the  interest  effective  corporations  tax rate can vary  (1983) present  deductions.  They  estimates of attribute the  in the effective tax rate across firms to a number  of reasons,  such as the progressive tax system, limitations on the use of investment  tax credits  and  tax loss  discrepancy  carry-back,  in mind,  other  Fischer,  non-debt Heinkel,  tax shields, and Zechner  etc. Bearing (1989)  find  this that  important a  higher  effective corporate tax rate causes a smaller optimal debt ratio range and a higher initial optimal debt ratio.  In view of this encouraging  result, we  include a tax variable in our model. The  EMPIRICAL variable  is the  (EFFTAX).  firm's  For negative  refund  or  subsidy),  matter  of  fact,  rates  for  coming major  the  effective  concern  is  According  to  tax  are  and  associated due  the  account  for  distressed  D.  We  firm,  examine  argue  from that  rationalize  of  and  preference common  the  is the  last  to The  of  aspects, level  relationship  longer  As  the  expected  and  at  the  time  Myers'  the  would  (1984)  stock  over  same  consider  according to  a  the  as  the  a tax  for  the  firm's  it  regains  effective  financing  no  pecking  is  loss order  common  the  rates  after  low  stock  time  above  effective  matter stock  tax  expensive.  preferred  same  zero.  effective  as  device derived of  tax  advantages  use  of  that  preferred  pecking order  from  may  For a  two  vis-a-vis its  advantage  theory  stock.  future  help  financially preferred  stock  first.  theory.  OF THE FIRM  firm's  namely,  financial  profitability  profitability on  to  stock  offers  the  equal  preferred  preferred  resort  set  anticipating  of  EBIT a  preferred  stock financing  to  represent  of  refinance  tax  45  might  expected  period  income  firms  Again,  firm  for  the  of  (which  arbitrarily  that  well  tax  proxy  attractiveness  for  of  a  ratio  hypothesis,  offer  CONDITIONS  two  higher  may  distress  is  as  a  as the  income  rate  preferred  stock  effect  the  it  defined  argue  for  bankruptcy  the  a  than  distress.  However,  stock  rate  years. W e  stock.  risk  THE FINANCIAL  choice  acts  likely  financial  does.  Common  tax  financial  more  the  negative  it finds the  the  lower  or  tax  rather  common  to  stock  if  rate  effective  survival  financial strength  rates  the  years  tax  earnings  ensuing few  "few"  bonds  effective  SPECIFICATIONS /  the  is  basis  conditions and  on  liquidity.  associated with of  direct  its  long-term  Martin  and  debt-issuing  relationship  financing  Scott firms.  between  (1974) They cash  EMPIRICAL generating confident hand,  ability and  to  a  profitability  borrowing  decrease  issuing  debt  (1977)  that  in  debt  anticipate  stock  more  the  used. income  The  the  capital on  of  to  total  notion  timing  amount to  level  the  of  signal g o o d  simple  of  debt  extent  ratio.  that  In  other  profitability.  future  generate  cash,  the  more  financing.  On  the  other  available  for  retentions.  earnings  prospects for  negative  the  means is  to  used  ratios  firm's  of  liquidity  existing  This  the  higher  words, is  to  earnings,  they  would  as  a  a  proxy.  operating  firm's  Two  income  over  the  with  market. find  of  Ross When  preferred  distress hypothesis.  expectations  measures  lead  likelihood  consistent  firm  identify  earnings  the  the  we  is less clear.  and  projected  include  current  assets  assets (LIQ2)  its choice of  with  to  This is basically Donaldson's (1962) financial  Nevertheless,  E. MARKET  The  the  of  ability  feel  debt-to-equity  even  the  46  of  sales  about  its  profitiability  are  (PROF1)  and  net  is that  the  assets (PROF2).  firm's  ratio  higher  the  earnings  include  the  capacity.  or  of  over total  greater  by  low  current  impact  with  better  increased  value  offerings  absence  These  be  The  management  means  book  attractive.  profitability,  the  can  increases  firms  In  profitability.  comfortable  higher  Therefore,  and  SPECIFICATIONS /  long-term  in  to  to  our  liquidity model  current  test  financing  if  All we  posture,  two  liabilities  there  is  can say about the  liquidity (LIQ1)  any  impact  it  greater  variables  its  as  debt  measured  and  the  ratio  working  of  the  firm's  liquidity  instrument.  CONDITIONS  of  security  market offerings.  efficiency However,  clearly it  rules  is not  out  the  possilibilty  u n c o m m o n , for  of  example,  gaining to  find  from equity  EMPIRICAL SPECIFICATIONS / 47 issues  preceded by periods of large  Capron  (1976), Taggart  follow  market  Mullins  (1986)  indicate  abnormal  returns  high  provide level  of long-term preferred  these  to  designed  where  t  =  a  issues  +  of interest  rates  issues.  Elsaid  a  include  reasonable general  our  Marsh  a  it t-1 E  +  a  2t t-2 E  +  a  3t t-1 M  determinant  of the  we  conditions. For  condition  These  stock  three  and  timing  variables are  and c o m m o n  use the  t-2.  The parameters  each  issue  using  a sixty month  of the model,  all available  variables  on the ten-year  period). redefined  information  from  The b o n d market  U.S. Treasury  a  4t t-2 M  monthly  Bonds.  a^,  a^f  month model level  +  U  issues  o n the equity  , a^,  as the  +  of new equity  and M^ ^ and M^ ^ are the returns  yield  (1982)  stock) and  following  model  to  market:  t-2,  explanatory  (1982),  to  of unusually  and Marsh  market  market  reality.  (preferred  tend  one of the main reasons for  three of  issues  periods  (1977)  of the favorable  description  Following  follow  H o d g e s , and  and Asquith and  is an important  model  equity  equity  (1982),  Taggart  (1969) finds that  advantage  in  to  Brealey,  that  Marsh  tend  the level  E^, E^ ^, and E^ ^ are the level  using  also  stock.  conditions.  0t  (1977),  company's  the  forecast the equity  E  equity  indicate  on the  we  reflect  market  that  excessive returns.  (1982)  Taggart  stock is to take  provide  to  and Marsh  addition,  debt  reasons,  variables  bond  In  evidence that  issuing all  rises.  (1977),  positive  t  in months  market a n <  t-61  ^  a  4f  t,  t-1 and  in months  t-1 and  a  up to  r  e  e s t  '  m a t e c  month  '  t-1  f°  r  (i.e.  is basically the same with the of  new corporate  bonds and  EMPIRICAL SPECIFICATIONS /  F. INDUSTRY  The a  CLASSIFICATION  security offerings  stronghold  (1988)  also  banks,  are  (IND)  is  utilities, and  in  the  banks  summarize, on  these  been the  to  other  and zero  preferred  the  recently,  banks.  industries,  stock.  view  is  In  an  institutions  of  industry  c o m m o n stock. The  otherwise.  probability broad  factors are  of  factors.  III  as  preferred Zechner  such this,  effect  defined  in  Heinkel  utilities  dummy  on  dummy  and  as  a  stock has  the  variable  choice  is equal to  the  and  one  Compustat  of for  Utilities  1 7  measured  firm's  These  and  the as  include  current  the  actually  market of  long-term  the  list  (1)the  of of  used  forecasts start  financing  market  a number  contains  variables of  a  (3)the  available  the  exception are  suggest that  regulated  there  financial  conditions, and  of  and  the  if  States  PREDICTIONS  the  three  definitions  variables  of  United  utilities, in  examine  suggested. Table  With  firms  users  and  Files  (2)its financial for  that  of  stock vis-a-vis bonds and  Banks  depend  financing  frequent  C. SUMMARY OF  To  statistics in the  suggest  included  preferred  48  choice  deviation  from  these in  the  of  the  three  univariate  which  of  its  conditions. N o  possible proxies  use  fiscal  is assumed debt  them  determinants  have  as  in  data,  just  well  multivariate  monthly year  target,  precise measures  for  and  to  as  analyses. all  other  which  the  issue  on  choice  occurred.  Table  IV  summarizes  the  predicted  effects  ' T h e S I C s for the utilities are 4911, 4912, banks and financial institutions are 6000-6700. 1  firm's  4923,  attributes  4924,  4931.  The  its  SIC's  for  of the  EMPIRICAL Table Variable Types  of  Firm  of  Definitions Proxies  Deviation  from  Target  Size  Asset  Compostion  Bankruptcy  current debt-to-equity ratio average of the ratio (DEV)  -  1. 2.  (SIZED  logarithm of total assets logaritm of sales (SIZE2)  fixed  Risk  assets/total  ten-year  assets ( A S S C O M )  1. (Interest - EBIT)/o(ten-year EBIT) (RISK1) 2. a(EBIT/total assets) (RISK2) 3. o*(percentage change in operating income) (RISK3)  Tax  tax/EBIT  Growth  49  III  Variables  Measure  SPECIFICATIONS /  Opportunities  (EFFTAX)  1. percentage change in total assets (GROW1) 2. (market value of c o m m o n equity book value of c o m m o n equity)?total assets (CROW2)  Profitability  1. 2.  operating income/sales (PROF1) (EBIT - tax)/total assets (PROF2)  Liquidity  1. 2.  current assets/current liabilities (LIQ1) working capital/total assets (LIQ2)  Bond Issue Forecast C o m m o n Stock Issue Forecast Preferred Stock Issue Forecast  forecasting forecasting forecasting  a Equity common b  The  variable  financing firms  is m e a s u r e d stock.  are  as the  is taken  instrument. compared  The to  sum  as the  book  logarithm  attributes those  of  of  of  values  of  bond preferred  the  model!? (BONFOR) model (COMRDR) model model (PFDFOR)  of  preferred  market  issuing firms stock  and  forecast.  and  issuing  stock  common firms  to  stock  issuing  examine  the  EMPIRICAL hypothesis from to  the  reflect  preferred of  across  the  hypothesis the  preferred  other the  two  The  profitability, three can  differential  interpretations  of  financial  two  of  (indirectly) instrument  predictions  The by  some  some  of  mentioned  hypothesis risk,  noting  across the in  characteristics  the  attributes  hypotheses  can  be  tested  and  tax  on  solution  described  results.  possess  addition,  bankruptcy  issuers.  empirical  In  do  previously  distress  liquidity,  financing  the  issuers.  the  tested  qualitative  issuing firms  of  of  groups  be  choice of  stock  types  impacts  stock.  effects  on  that  SPECIFICATIONS /  to  the  adverse impact  three Table  of  groups IV  are  on  by  the  are  used  use  examining  financing  growth of  different  the  investment  50  of the  choice  incentives  opportunities  issuing firms. important  for  The the  EMPIRICAL Table  SPECIFICATIONS /  51  IV  Predicted Effects of Firm Attributes o n C o r p o r a t e Financing C h o i c e A m o n g B o n d s , C o m m o n Stock, and Preferred Stock (As C o m p a r e d With Preferred Stock) Explanatory Variable Deviation from Target Firm Size Asset Composition Bankruptcy Risk Tax Growth Opportunities Profitability  Bonds Negative Positive Negative Negative Positive Positive Positive Positive Positive None  C o m m o n Stock' None (37) None or Negative None (40) Negative (41) Positive (44) Positive (43) Positive (45) Positive (45) None (46) Positive (46)  Negative  Negative  3  Liquidity Bond Issue Forecast C o m m o n Stock Issue Forecast Preferred Stock Issue Forecast  3  C  (39)  (46)  a Positive effect indicates that an increase in the explanatory variable increase the probability of issuing b o n d s vis-a-vis p r e f e r r e d stock.  would  b Positive effect indicates that an increase in the explanatory variable w o u l d increase the probability of issuing c o m m o n stock vis-a-vis preferred stock. c The n u m b e r refers to variables are d i s c u s s e d .  the  page  on  which  the  predicted  effects  of  the  VII.  A.  THE  AND  SOURCES  OF  DATA  SAMPLE  The  discrete  two  sections,  offerings  corporate is  made  using  corporations  from  the  stocks,  and  preferred  Financing  stocks  Record.  1  during  all  was  a  public in  detailed sample  period  identified  sample  was  with  the  of  were  The  which  associated  population that  8  model,  data  U.S.  drawn  selection  choice  by  was  Investors'  financing  estimated  sample  1.  SAMPLE  1977  formed  by  of  the  of  previous  public  through  issues  various  in  security  1986.  bonds,  issues imposing  of  The  common Institutional  the  following  criteria:  Multiple firms  issues  that  preferred, the  within  publicly within  restrictions  the  same  issued  the of  both  same the  fiscal bonds  accounting  logit  year  model  were  and  year is  stocks,  were that  excluded. be  they  eliminated  the  In  other  common  because  alternatives  words,  be  one  or of  mutually  exclusive. 2.  Firms  having  ten  year  the  Annual  an  period  incomplete prior  Compustat  to  history  the  Industrial  of  issue were  accounting  and  financial  excluded.  The  data  was  data  for  available  the on  Files.  The Financing Record of Institutional Investors reports SEC registered public negotiated and competitive offerings in the U.S. on a monthly basis. The report includes offerings of $2 million or more for the period January 1977 through O c t o b e r 1982, offerings of $10 million or more for the period November 1982 through April 1983, and offerings of $25 million or more for the period May 1983 through December 1984. For the period January 1985 through December 1986, the Financing Record only includes negotiated debt of $50 million or more and all other categories of a minimum of $25 million. This imposes a limitation on data availability and may cause a selection bias in the formation of the "population" of issuers. Therefore, interpretations of the results obtained from the logit regressions should be handled with caution. 1  8  52  3.  The  common  stock  Exchange for 4.  of  the  a period of  Secondary distributions occurred were  The  resulting  offerings, offerings.  An  455 1  generated  capital has  were  bond  and  the  way  the  964  issues,  on  be  listed  sixty months  stock  where  issues,  and  history  the  is  between samples  is  of  the  the  prior  no  DATA  New  to  change  which  balance  observed by these  shortcoming  of  over  a  a  York  the in  /  53  Stock  issue.  capital  structure  429  were  common  stock  80  were  preferred  stock  of  and  Cragg  (1970)  This  problem  where  there  of  small  sample  multinomial  logit,  which  requires  this  the  study,  problem  issues that  do  not  is  are  only  size  is  large  the  then  This  sample  of  to  time.  constitute size  for  the  stock  concern guarantee  focussing on  the  in  of  study  firms total  less  most  and  their  number  case found  the  estimation  asymptotic  are  in  their  used Baxter  sample. of  the  properties. of  of  method  frequently  issues in  is  In  sample. This  issues instead  sample selection criteria  this  created.  The  those  is exactly  in  are  population  preferred  major  used  studies  a  period  five a  by  similar  sample  stock.  remedied  meet  firms  sample  from  given  small  the  other  drawn  selected  having  how  of  usually  financing vechicles such as preferred  those  to  OF  out.  exists  sample  issues made  the  less than  common  contained  difference  studies,  financing  of  had  SOURCES  9  intrinsic  other  no  also ruled  sample  firms  SAMPLE A N D  firms.  In  Only  eliminated.  A total of more than 3,500 public security issues made for the ten-year period 1977 through 1986 were reported on the Financing Record. Approximately half of them were multiple issues which were offered mainly by public utilities and banks. Roughly 400 of the remaining had their issuers identified as American Stock Exchange (AMEX) listed firms. As the CRSP tape does not contain monthly stock returns data for firms listed on the AMEX, these firms were also excluded. 1  9  SAMPLE Table  V  and VI  security.  It  included groups  in of  electric, of  is  show  breakdown  interesting  the  and  manufacturing  to  sample  preferred  gas  the  come  stock  sanitary  note  by year  that  from  issuers  are  services  firms  concerns (two-digit  half  period  the  group  (two-digit  SIC:  SOURCES  and by industry  almost  the  AND  20-39).  of  the  1983 of SIC  for  OF  each type  preferred  to  DATA  1986.  /  of  54 the  stock  issues  two  major  The  transportation,  communication,  range:  and  (two-digit  40-49),  SIC  range:  the  group  60-67).  B. SOURCES OF DATA  The  data  associated with the  preferred  stock,  collected  from  sample stock  a  common  variety  of  firms  were  obtained  returns  were  taken  Monthly  Index  various  issues  Preferred and  or  Poor's  stock  File. of and  Security  sample  bond Price  stock  from  from of  Index  that had the  Annual  monthly  new  security  Record.  obtained 2  Financial from  the  either  through  bonds,  1986  were  accounting  data  for  Industrial  Files.  Monthly  Compustat Research  offered  1977  and  for  Bulletin's  were  publicly  period  financial  Center  Reserve yields  The  the  the  firms  during  sources.  Volumes Federal  of  in  Security  issues and 1988  were  Prices  (CRSP)  collected  Business edition  the  from  Statistics.  20  of  Standard  1  ° O n l y public sales of debt figures were taken because of the non-availability of privately placed b o n d issues in most of the issues. T h e preferred stock yield indexes were based upon ten high-grade non-callable issues with the yield for each being determined and the average of the four median yields representing the group yield. The b o n d yields were represented by the yields on U.S. Government Bonds with intermediate maturities, that is, maturities of more than six years but less than nine years. 2  2  1  SAMPLE A N D Table Sample Calendar 1977 1978 1979 1980 1981 1982 1983 1984  Year  of  Bond,  Common  B o n d Issues 29 22 32 50 29 41 42  1985 1986  43 73 94  All Years  455  OF  DATA  by  Year  /  V  Stock, and Common  SOURCES  Preferred  Stock  Stock  Preferred  Issues Stock  Total  Issues 36 47 39 57  Issues 5 4 7 4  50 55 82 11 22  85 102 137  30  6 6 13 9 9 17  429  80  964  70 73 78 111  63 104 141  Issues  SAMPLE Table Sample  of  Bond,  Common  Stock,  AND  SOURCES  OF  DATA  VI  and  Preferred  Stock  Issues  by  Industry  Common Stock Issues  Preferred  1  0  1  2  Mining  15  13  10  38  15-17  Construction  2  3  0  5  20-39  Manufacturing  219  154  30  403  40-49  Transportation, 134 communication, electric, gas and sanitary services  187  32  353  Two-Digit SIC Range  Industrial Group  Bond  01-09  Agriculture, forestry, and fishing  10-14  Issues  Stock  Total  Issues  -  50-59  Wholesale and retail trade  62 , •  45  4  111  60-67  Finance, insurance, and real estate  4  1  2  7  70-89  Services  18  26  1  45  455  429  80  964  All  Industries  /  Note: T h e classification of the above eight major industrial groups is a d o p t e d f r o m the 1986 Standard and Poor's Register of C o r p o r a t i o n s , Directors and Executives, V o l III.  VIII. RESULTS A N D  The of  empirical the  group  fall  independent means  multivariate logit  results  into  variables  and  based  categories.  based  Duncan's  analysis  two  on  multiple  on  DISCUSSIONS  the  The  one-way  range  involves  analysis  test.  maximum  first  The  likelihood  of  a  univariate  analysis  among  different  variance  second  category  estimation  of  comprises  the  a  multinomial  model.  A. UNIVARIATE ANALYSIS  Before on  any  meaningful  a  univariate  basis  bond,  common  stock,  multivariate the  insights  into  corporate  choice  among  means  to  select  variables  group  means  regression variables  for  (A  including  Appendix  I.)  group  preferred  of  issuing variables issuers variable  It  group  and  listed lying  is  the  in Table  as  given  are to  issuers do  stock  VII  their  have values  measured  by  for  mean the  the  logit  variables  from  between  the  group.  the  the of  Only  two  logarithm  of  only  variables  on  the  serves  as a  also  Table  mean  two  in  the  for  is  of  given  of  for the  the  the  bond  the in the  bond eleven  preferred include  the logit  all  values  out  group  and  gives  values for  groups. These sales  VII  model  mean  namely, not  distributions  the  examine  analysis  included  final  values for the  other  57  of  are  to  issuers,  but  model.  that  majority  issuing  univariate  alternatives,  description  fall  of  independent  final  that  not  common  the  the  is instructive  groups  issuers. The  excluded note  it  three  financing  independent  that  the  out,  individual  comprehensive  interesting stock  of  inclusion in  the  those  between  (SIZE2)  three  for  more  stock  effects  the  of  among  preferred  the  each  model.  differences  and  provides  analysis is carried  stock  the  size  market  RESULTS A N D Table Group  Means  of  DISCUSSIONS  Independent  Variables  in  the  Logit  Model  Common Stock  Preferred Stock  All  Deviation DEV from Target  -0.027  -0.004  -0.028  -0.017  Determinants SIZE2  7.36  6.07  6.89  6.75  0.54  0.58 -2.34  0.62 -1.44 0.41 0.055  0.56 -2.36 0.44 0.25  of  Variable  Variable  of  Target  Financial Conditions  Market Conditions  ASSCOM RISK1 EFFTAX GROW2  -2.55 0.44 0.17  LIQ1  1.66  1.63  1.40  1.63  PROF2  0.071  0.075  0.056  0.072  PFDVOL  5.86  5.74  5.90  5.81  BONVOL COMVOL  8.59 7.45  8.13 7.29  8.49 7.56  8.38 7.39  455  429  80  964  Number of Observations  forecast suggests lying  To  (BONVOL) that  between  examine  analysis the  58  VII  Bonds  Type  /  of  results  except  two  significance. effective  tax  if  as  that  those  of  the  rate  bond  and  two  by  and  are  (EFFTAX).  of  significantly  In  stock  are  other  of  do  the  bond  possess  issue  some  forecast.  This  characteristics  not  stock issuers.  different  multiple  analysis  exceptions  logarithm  common  Duncan's  have  the  preferred  means  one-way  variables The  issue  group  variance of  measured  firms  the  0.45 0.37  from  range  variance. different the words,  each  test The  are  the  at  Table  F-test  the  from  three  both  used.  overall  means  deviation  other,  five target  groups  of  the  one-way  VIII  reports  indicates  that  all  percent  level  of  (DEV) issuers  and  the  are  not  RESULTS Table Univariate  A N D DISCUSSIONS  VIII  Tests of Significance : Analysis of  Variance  Variable  F-Value  Prob>F  Deviation from Target (DEV) Firm Size (S1ZE2) Asset Composition  0.21  0.8070  97.47 6.53  0.0001 0.0015  20.01 0.81 18.22  0.0001 0.4446 0.0001  3.93 10.89 11.36  0.0200 0.0001 0.0001  44". 54  0.0001 0.0001  (ASSCOM) Bankruptcy Risk (RISK1) Tax (EFFTAX) Growth Opportunities (GROW2) Liquidity (LIQ1) Profitability (PROF2) Preferred Stock Market Forecast Bond Market Forecast C o m m o n Stock Market Forecast  significantly effective bond,  different  tax  rate.  common  composition, However, overall  stock,  bankruptcy  It  each  O n the  the origin  F-ratios.  9.08  from  of  other  and  other  on  hand,  preferred  risk,  the variation  is not known  the  there stock  growth  / 59  basis  of  deviation  are significant issuers  opportunities,  in group  means  in  from  differences  terms  of  liquidity, cannot  target  and  among  the  firm and  size,  asset  profitability.  be identified  with the  if the variation  originates  between  comparisons or among  the three  groups of issuing firms.  possible  sets of pair-wise  In view  of the shortcoming  of the overall  F-test,  Duncan's  multiple  any one of the  range  test  2 2  is  Duncan's multiple range test basically involves two steps: first, the group means are ranked from the highest to the smallest; second, two group means are tested for equality each time, starting with the pair of the largest and the smallest. Their difference is then compared to a tabled critical point whose value depends o n the range of the ranks of the two tested means: the larger the rank difference, the 2  2  RESULTS A N D used  to  address  contains  the  results  significance, general firms.  the  the  In  only one  between  instances,  the  the  bankruptcy variables These  are  results  attributes target  risk  of  (DEV),  opportunities  only  the  three  mean  for  the  actually further  asset  composition  stock  of  issuers differ  of  preferred  stock  some  of  the  some  attributes  While  each  issuers  cases.  The  that  are  and  that  the  issue four  other  in  appears results  univariate most  to  suggest  different  from  of  and  firm  is  stock  the  firms.  firm  do  namely,  distinct that  firms  firms  that  is  that  the issue  issue  the  some  deviation and  the  other  three  hypothesis.  two  preferred other  two  from growth  the  three  encouraging that  from  (SIZE2),  have  (EFFTAX),  four  different  last  distress  analysis shows that it  In  size  The  stock  group  variation  statistically  (PROF2).  rate  issuing  in the  cases,  include  financial  indicates a  non-distinguishable from  cases,  be  level  issuing  instances,  stock issuers are the  of  tax  percent  variation  preferred  effective  IX  preferred  profitability  examine  Table  test  all other  groups  These  (ASSCOM),  and  60  groups.  five  variance  In  groups.  remaining  preferred  issuers.  from  the  issuers.  issuing  firms  a  size (SIZE2), the  stock  to  among  At  stock,  three  (LIQ1),  that  own.  common  two  used  their  (GROW2),  In  than  preferred  liquidity  variables  firm  groups of  other  indicate  the  test.  analysis of  common  rather  for  differences  range  the  bond,  two  (RISK1),  or  multiple  instance, namely,  group  means  individual  is consistent with  among the  originates  of  Duncan's  among  means originates  from  of  test  difference  question  DISCUSSIONS /  bond groups  the  group  groups stock  in  have  types  of  financing, that is, bonds and c o m m o n stock.  (cont'd) larger the tabled critical description of the test (pp.57-63). 2  2  point.  Refer  to  Freund  and  Littell  (1981)  for  a  RESULTS A N D Table Univariate  Tests of  DISCUSSIONS /  61  IX  Significance : D u n c a n ' s M u l t i p l e  Range  Test  (Alpha = 0.05) Deviation from Target (DEV) Firm Size (SIZE2) Asset Composition ( A S S C O M ) Bankruptcy Risk (RISK1) Tax (EFFTAX) Growth Opportunities Liquidity (LIQ1) Profitability (PROF2)  C o m m o n = Bond = Preferred Bond Preferred C o m m o n Preferred = C o m m o n C o m m o n = Bond Preferred C o m m o n = Bond C o m m o n = Bond = Preferred C o m m o n Bond = Preferred Bond = C o m m o n Preferred C o m m o n = Bond Preferred  (GROW2)  Preferred Stock Market Forecast (PFDVOL) Bond Market Forecast ( B O N V O L ) C o m m o n Stock Market Forecast  Preferred = Bond C o m m o n Bond = Preferred C o m m o n Preferred = Bond C o m m o n  (COMVOL)  N o t e : T h e three types of f i n a n c i n g are arranged in d e s c e n d i n g o r d e r of their m e a n values. T h e equal sign indicates that the two types of f i n a n c i n g are not statistically significantly different.  B. MULTIVARIATE ANALYSIS  Multivariate  Analysis  Clearly,  it  despite  the  power.  Having  in  a bulky  problem are  is  fact  arises  that  but  from by  the  appropriate more  a large  model  measured  other.  not  involves  a  to  the  of  that of  all  of  the  the  variables  variables  variables  a model  fact  number  include  relevant  number also  estimation  with  some  proxies  may  in the high  add final  degree  determinants which  are  multinomial  in  in  the  logit  regression  information model of  of  coefficients.  would  and  model  explanatory  not  only  result  multicollinearity.  The  latter  corporate  principle  financing  correlated  with  choice each  RESULTS A N D According  to  the  model  multinomial  logit  alternatives  has  to  designated  as  the  compared. dealing  model  Thus,  with  the  final  primarily industry target the  their  (DEV);  assets  including  (R1SK1),  common (EFFTAX);  two  tax  but  of  current  (i)the  (iii)the  (iv)the  equity  before  interest  assets  to  the  by  current  and timing  variables.  Table  shows  correlation  dummy  (IND).  correlation (0.44),  the All  except  coefficient  PROF2  and  six  the  and  five  liquidity  the  by  second  one  is  and  for  of  and  the from  book  include  the  of  fixed  Turnbull value  effective  and  based  determinants  profitability  (L1Q1);  one  deviation  White  (v)the  for  is  first  percentage  conditions which  assets (PROF2)  the  are  (except  the  for  value  and  a  stock  selection  test  (ii)the  market  of stock  the  the  in  stock.  the  developed  (CROW2),  for  with  measuring  (SIZE2),  variable  preferred  equations  range  sales  as one  common  which  multiple  one  run  62  of  tax  rate  earnings  after  and  ratio  the  three  market  ( B O N F O R , C O M F O R , and PFDFOR).  matrix pairs  (i.e.<0.30).  RISK1  of  be  and  preferred  (IND);  financial  total  and  to  case,  stock  effect  assets  liabilities  condition  X  risk  firm's  scaled  of  two  variable  between  total  the  variables  minus  our  preferred  stock  industry  logarithm  by  and  one  equations  bonds  of  Duncan's  bankruptcy  for  consists  include  difference  scaled  proxies  in  In  which  bonds  of  altenatives  referent.  twelve  These  of  common  are  measuring  (ASSCOM),  (1974)  between  there  number  to  model  performance  one  the  alternative  resulting  IND).  the  number  as  choice between  dummy,  target  base  model,  on  the  chosen  choice  dealing with the  In  equals  be  the  the  specification,  DISCUSSIONS I  (-0.53),  The  for  of  all  variables  high  ASSCOM  these show  correlations and  variables  LIQ1  a  except  generally  between (-0.62),  low  PROF2  and  the  industry  degree  and  among  of  GROW2  the  three  RESULTS A N D Table Correlation  Matrix  DISCUSSIONS /  63  X  fot• the  Variables in  the M o d e !  DEV SIZE2 0.01 -.07 -.02 -.21  -.06 -.06 0.15 -.01 -.01 0.07  ASSCOM RISK1 0.00 -.00 -.15 -.32 -.15 -.62 -.01 -.16 -.53 -.13 0.13 -.14 0.04 -.13 0.22  -.05 0.05 0.03 0.04  -.15 -.16 0.15 0.27 0.21  market  forecast variables  a  matter  of  concern  two  major  the  coefficient  inflated be  statistically  potential  problems,  be  to  avoid  deleted.  the  Any  a  all  LIQ1 0.18 0.07  0.03 0.03  0.08 0.10  0.05 0.06  indicate  estimation  and  is  significant dependent  0.28 0.44 0.10  that  the  variable  and  moderately  specification  specification  error  error  estimated  of  there the  exists of  a  logit of  the The  are  by  dropping  variables  model  would  result  are  consequence  of  and  may  not  relationship  Despite  retained  in  There  of  variables.  are  which is  standard errors  statistical  variables  caused  model.  unstable  definite  explanatory  correlated  the  multicollinearity  signs.  coefficients  set  PFDVOL 0.67 BONVOL 0.74 0.70 COMVOL  multinomial  (1)general inflation  resulting  though  PROF2 -.10 -.08 -,12  presence of  the  (2)incorrect  even  the  the  of  multicollinearity:  errors  the  model  in  estimates,  between  0.01 0.05 0.01  (0.67-0.74)  symptoms of  standard  EFFTAX 0.02 GROW2  in  that biased  these  the  should  final not  coefficient  estimates.  Table  XI  presents  the  coefficient  estimates  for  the  multinomial  logit  model.  2 3  The  It should be noted from Table VI that there are only seven security issues made by the group of finance, insurance, and real estate firms. The main reason is that most of the firms in the group, mainly banks and financial institutions, have missing data in one or more variables on the Compustat File. In view of this small sample size, care should be taken on the interpretation of the industry dummy, IND. 2  3  RESULTS A N D DISCUSSIONS / 64 Table  Maximum Likelihood parentheses)  Variable  Estimates  (x)  XI  f o r the M u l t i n o m i a l  Bonds  Logit (standard  (Pi)  Common  CONSTANT  0.1329 (2.0916)  8.7867  DEV SIZE2 ASSCOM RISK1  0.1818 (0.2238) 0.2664 (0.1007) -0.8062 (0.7574)  0.2342 -0.2731 -0.4267 -0.2802  3  EFFTAX CROW2. LIQ1 PROF2 PFDVOL BONVOL  -0.4018 (0.1188) -0.1497 (0.3512) 1.0186 (0.6737) 0.5078 (0.2631) -1.0233 (5.0116) -0.2728 (0.4822) 0.3556 (0.2434)  COMVOL IND  -0.3833 (0.3168) 0.2726 (0.3835)  Number of Number of Number of Number of Pseudo-R 2  Observations = 964 Bond Issues = 455 Preferred Stock Issues = C o m m o n Stock Issues = = 0.35  a  0.1651 2.3576 0.4408 -3.7770 -0.4803 -0.7679 0.3212 1.0925  errors  Stock  in  (/J^)  (2.1874) (0.2225) (0.1020) (0.7657) (0.1199) (0.3388) (0.6757)* (0.2648) (5.0787) (0.4875) (0.2508) (0.3136) (0.3823)  3  3  3  a  80 429  Note: Estimates are for the coefficients of the logarithms of the o d d s in of the alternative m e n t i o n e d in the c o l u m n h e a d i n g over the issuing of p r e f e r r e d stock.  favor  a A c o m p a r i s o n with the n o r m a l distribution table indicates that the is different f r o m zero at the five percent level of significance.  coefficient  b A c o m p a r i s o n with the n o r m a l distribution table indicates that the is different f r o m zero at the ten percent level of significance.  coefficient  first  column  bonds  of  the  and preferred  for  the  logit  The  estimated  table stock  regression coefficients  displays are  where  the  compared. common  in each  equation  estimates  for  The second stock  and  determine  the  logit  column  preferred  regression  gives stock  the effects  the are  where  estimates compared.  of changes in the  RESULTS A N D explanatory between of  the  of  variables  expected  level  of  t-values  and  incorrect  (1970),  Marsh  0.35  all  equation)  4  to  percent  level  significant  and  liquidity  the  of  the  both  two  equation  common  stock  the  percent  market  estimates  While  forecast  The of  with  signs.  with  stock  probability  results the  of  by  65  choosing  mixed  in  terms  While  some  some  pseudo-R  obtained  equations the  a  negative more  and  expected  have  2 2  low  for  5  Baxter  have  common are  firm  the one  variable  and  of  latter  SIZE2  as  the Cragg  which  a  common  include  growth  at  the  positive  ten  coefficients risk  (RISK1),  are  both  In  in the  significant  opportunities  estimate  the  equation.  (IND). The  bonds  coefficient  estimates  in  (hereinafter  variables  stock  coefficient  three  the  equation  two  has  dummy  to  bankruptcy  have  industry  only  significant  (SIZE2),  the  the  variables  the  variables  of  in  stock  t-values  size  signs,  referred  versus preferred  significance. These  (BONVOL),  the  (hereinafter  coefficients  and  three  have  "The t-value is defined as the ratio of the coefficient error. P s e u d o - R is defined as: Pseudo-R = {l-exp[2(L -L )/N]} / {l-exp[2(L -L )/N]} 5  of  coefficients.  value  figures  2  2  are  expectations,  The  equation)  three  equations,  of  accord  stock  logit  level  stock.  equation  common  logit  equation,  relative  significance  which  stock  significance. The  in  the  /  Billingsley, Lamy, and T h o m p s o n (1988).  common  (LIQ1).  in  bonds  in the  in  comparable  preferred  half  as  are  is  coefficient  versus  referred  even  (1982), and  and  five  2  which  the  bonds  negative  the  of  preferred  are  is  Among  signs and  and  estimates  model  bond  logarithm  coefficient  reported  the  the  b o n d s / c o m m o n stock  the  the  on  DISCUSSIONS  at  (GROW2),  results suggest to  its  standard  2  2  logarithm oHne likelihood function C  only  where L is the maximum of the when the term is used; L is the maximum when all the variables are used; and L is the maximum possible value of L within the model. N is the number of observations. P s e u d o - R is identical to R-squared in the multiple regression model. See Maddala (1983, pp. 37-41) for a detailed discussion of the measures of goodness of fit for the multinomial logit.  constant  2  RESULTS A N D that all that  firms  that  these are  significant smaller,  bonds;  and  bigger,  riskier,  stock.  Also,  common to  For  and  the  use of  other of  PROF2  in  positive  both  sign  composition,  coefficient  be  positive  deviation minus  the  contrary target  yield  the  a  turn  out  to  among  the  three  tax  DEV  rate,  (defined average)  theory  of  increase the role  of  this  odds of variable  of  ten  (They  negative).  firms  and  than  that  are  common  inclined  utilities  firms  stock  stock than  more  Finally,  in the  sign  bonds,  by  to  issue  banks  tend  stock.  the  EFFTAX  from  Given  financing  target)  positive the  would  optimal  are  composition), at  with  stock,  issue preferred  stock.  proxied  issue preferred  common  66  particular,  EFFTAX percent  level  all  these on  coefficient  (effective  tax  and  those  supposed to results,  the  rate),  of significance.  bonds equation were  the  firms  basis  of  of  have seem  their  a to  asset  profitability.  The as  of  types  and  with  attributes  compared  less encouraging. In  (asset  all  is  likely to  preferred  wrong  be  (deviation  insignificant.  target  the  would  concerns  equations  historical  preferred  insignificant  estimates  yet  to  all  by some  opportunities  results are  are  more  likely to  growth  coefficient  of  from  more  ASSCOM  stock  compared  c o m m o n stock over  effective  The  is  compared with  variables  but  indifferent  are  larger  PROF2 (profitability) still, the  preferred  stock  variables, the the  characterized  less liquid are  less liquid with  are  When  and  preferred  firms  favor the  Worse  be  riskier,  when  stock  variables.  stock when  estimates and  issue preferred  DISCUSSIONS /  current  increase capital  in  the  sign  implies  debt the  structure  ratio  where over  that  the  equation  that  an  prior  likelihood  issuing equity measures  bonds  to  of  debt. firm's  increase the  selling  positive In  turns  deviation  in  to the  security issue bonds. This is  deviation fact,  out  the  from result  from  its  the that debt  RESULTS A N D target  is surprising. In  deviation  from  implying bonds  that  and  studies evidence from  The are  financing  choice  the  and  Thompson  either  In  issue.  their  the  This  As  provides  a rough estimate  ratio of  after  optimal  deviation security issuing be  mentioned  the  from issue  a  issue  debt  target). falls within  a determinant  As  the  security.  of the  debt  security  result  may  be  historical  (DEV) has  not  between  stock. Previous  that  provide  a  deviation  between  debt  in  two  no  stock  or  the  influence between  comparable  unknown also as  optimal  factors  issue  if  is  the  nor  and logit  on  the  common  due  as the  the  taken  of  a  unobservable.  it  such  firm  as to  ratio  partly  the  a  one  for  the  debt  is hard as  financing choice.  In  ratio to  before the  market  raise the  possible  ratio  only  optimal  debt  addition,  predict  favorable  of  debt  insignificance  the  before  number  firm's  to  to and  which  chose  security offering. The  current  range,  taken  attributed  account  the  is  average  its target after  ultimate  insignificant,  (1988)  find  choice  variable  ratio  study  Other  They  however,  this  long  preferred  ratio.  preferred  in  may  both  Thompson  target  the  are  and  financing  from  are,  the  the  neihter range  the  the  financing choice either  debt  and  the  used  for  the  coefficients of  used in Marsh (1982) and Billingsley, Lamy,  after  earlier,  is  ratio  particular  results  unexpected  reasons.  on  bonds  studies,  ratio  optimal  deviation  ratio  equations  Lamy,  implying that  The debt  on  67  expect, the  c o m m o n stock and  of  the  immediately  contrast,  influence  impact  between  of  logit  Billingsley,  an  stock.  two  between  insignificant,  (1988).  By  security  both  have  no  notion  of  what one would  the  and  has  definition  would  debt.  ratio  preferred  different  firm  (1982)  coefficients  equations  stock  has  supports the  target  in  stock or  Marsh  that  (DEV)  variable  preferred  the  equity.  target  the  by  opposition to  DISCUSSIONS /  the  notion  of  DEV  (the  and  after  the  probability conditions  of may  RESULTS AND Apart from that issue  providing preferred  information stock,  DISCUSSIONS / 68  about the financial characteristics of the the firms  the coefficient  estimates can also be used  the two previously stated hypotheses about the motivation  to examine  for the use of preferred  stock.  It  can be seen RISK1  variables partial  support  financial  that  the mixed  (bankruptcy  risk),  for the financial  distress are more  results about  the coefficient  LIQ1 (liquidity),  and PROF1  distress hypothesis,  likely  to issue  preferred  which  estimates  (profitability)  states that  stock.  for  the  provide  firms facing  Of all the coefficient  estimates of the four variables, those of RISK1 (bankruptcy risk) and LIQ1 (liquidity) are significant at the ten percent firms  with  probability  significant.  The variable  stock equation.  stock.  not only  and a strain This  measures  a lower  with  have  yet insignificant  an  that  increased  the financial distress  the effective tax rate  is, however,  coefficient  estimate  less  in the  One might argue that firms with a lower effective tax rate  (EFFTAX) in the bonds  stock  over common  equation,  stock. Along  the profitability  variable  has coefficient estimates not significant but are also of a wrong  sign, contradicting the financial distress hypothesis. have  signs, implying  in liquidity  is consistent  probability of issuing preferred  the tax variable  (PROF2)  that  risk  It has a correctly signed  have an increased with  bankruptcy  of issuing preferred  hypothesis.  common  a higher  level and have the predicted  profitability  and tax rate  preferred stock. Also, firms with a higher preferred  stock  over  common  stock.  consistent  and partly inconsistent with  That result implies that firms that  are more  inclined  to issue  bonds  than  level of profit tend to favor the issue of In sum,  the empirical  the financial  evidence  distress hypothesis.  argue that the wrong signs might be attributed to the existence  is partly  One  might  of multicollinearity.  RESULTS As  noted  above,  PROF2  correlated  with  drive  the  less influential  The  variable  hypothesis between The  the  market  the  estimates  probability  bonds  equation  lends  hypothesis, over-  some  which and  final  condition  and  predicted  signs  attributed  to  likelihood  of  for It  that is  the  compared  to  security  surprising  it  not  that  the  of  negatively  worth  The  coefficient  of  the  as  may  difference  scaled by total assets.  in  both  growth  stock,  the  bonds  opportunities  with  the  incentives  the  preferred although  ten  the  percent investment  be  used  a means  as  caused  by  that  the  would and  estimate  level.  This  incentives to  common logit  and  stock;  adverse  most  the  The  other  bond  of  level  is positively to  RISK1  investment  defined  mentioning  low  multicollinearity.  related  of  eliminate  equity  model  in  and this  hypothesis.  expected,  security  moderately  to  emphasized  significant.  particular  the  are  can  at  problems  of  in  69  sign.  compared  preferred  stock  be  test  As  increase  when  incentive  variables.  presence  and  an  are  significance  equity  positive  solution  preferred  that  are  is  DISCUSSIONS /  risk)  adverse  insignificant  the  should  to  common  with  marginally  variables  issuing a  words,  high  which  of  variable  "indirect"  although  solution  issuing bonds  support  timing  the  other  is  However,  of  a wrong  the  claims that  group  yield  of  when  study only serves as an  The  PROF2 to  opportunities),  under-investment  financing.  The  b o o k value  In  (bankruptcy  0.53.  and  of  stock  finding  debt  value  common  the  the  (growth  R1SK1  of  examine  stock equations.  increase issuing  to  and  coefficient  variable  CROW2  coefficient  common  in  a correlation  used  is  (profitability)  AND  is the of  the  group  coefficients significance  coefficients related security  market  of  to in  have is  indicate the  market  the  forecast  in  market the  probably that  the  forecast  logit  equation.  the  common  RESULTS A N D stock  equation  bond  issue  common  stock.  be  To  summarize,  Xll(a) XI 1(b) stock.  both  forecast  not  among  is  compares compares  would  Whether  so strongly  bonds,  negative  increase  common  related  the  to  predicted  preferred firms firms  and  stock,  that that  the  and and  issue issue  significant. the  likelihood  stock  or  bond  market  actual  of  that  issuing  an  increase  preferred  stock would  be  /  in  stock  offered  70 the  over  should  forecast.  effects  with  common  implies  preferred  common  bonds  This  DISCUSSIONS  stock firms equity  of  the  are  variables  presented  that with  issue firms  on  the  in Table  preferred that  choice  XII.  Table  stock.  Table  issue  preferred  RESULTS A N D Table Predicted a n d Actual Effects of Firm Between B o n d s and Preferred Stock  Attributes  on  EFFTAX CROW2 LIQ1 PROF2  Positive Positive Positive Positive  Negative Negative Positive Positive Negative  PFDVOL BONVOL COMVOL  Negative Positive None  Negative Positive Negative  Significance  =  Significance  =  Choice  Not Not Yes Not Not Not Not  0.10  Predicted None None or None Negative Positive Positive Positive Positive Negative None Positive of  Financing  Not Yes Not Yes  Positive Negative  Xll(b)  Predicted and Actual Effects of Firm Attributes Between C o m m o n Stock and Preferred Stock  Level  Corporate  Actual Positive  Table  Variable DEV SIZE2 ASSCOM RISK1 EFFTAX GROW2 LIQ1 PROF2 PFDVOL BONVOL COMVOL  71  Significant  Predicted Negative Positive Negative Negative  of  /  Xll(a)  Variable DEV SIZE2 ASSCOM RISK1  Level  DISCUSSIONS  Negative  0.10  on  Actual Positive Negative Negative Negative Positive Positive Positive Negative Negative Negative Positive  Corporate  Financing  Significant Not Yes Not Yes Not Yes Yes Not Not Yes Not  Choice  or  Not  IX.  While the  the  empirical  relationship  firm-specific limitations of  the  multinomial  As  noted  preferred light  in  on the  stock.  This  choice  of  more  of  suggestive  The  two  This  ih  stock  limitation logit  This  alternatives  that  from  stock  the the  a  are  in  not  is  stock  context  been  has  devoted no  and  the  some  underlying  a specific theory  (2)the  restriction  made  if  to  the  of  the  not  subject  specific theory  stock, bonds,  be  at  As  best  of  has shed  and  predictions  imprecise.  should  one  major  is  unaffected  use  certain  of  the  of  by  common  about  this  the  study  considered  extent  assumption Irrelevant  choosing  the  is as  is  a  financing  the  between  logit  results  substitute although  for the  of  the  Alternatives  presence of  multinomial  Otheiwise,  corporate  72  from  probability  substitutes. to  to  Independence  relative  the  of  are  lack of  stock,  preferred  related  of  choice set  close  choice  into  explanatory.  the  restricts  (1)the  Virtually  results  property  given  preferred the  the  study  asserts that  property  Clearly,  has  ambiguous  than  what  insights  use of year-end accounting data.  underpinnings  nature,  provide  financing  common  literature.  somewhat  of  model:  assumption  and  financing choice among  theoretical  section  understand  stem from  attention  finance  and descriptive rather  alternative.  common  of  to  bonds,  little  previous  corporate  important  stock,  corporate  exploratory  alternatives  weakened.  also  beginning,  corporate  an  the  long-term  model, and (3)the  preferred  second  multinomial (MA).  the  lack  is  preferred  logit  stock  it  the  in  study. These limitations  among  the  discussed  between  attributes,  of  choice  results  LIMITATIONS  a  model  any third to  would  be  bonds  and  degree  of  LIMITATIONS substitution issue find  is  preferred out  problem  the of  Finally,  the  of  firm  the  take to  unknown.  place  are  relative  purpose  characterized  probability  of  of  by  a  this  study  set  of  choosing  is  to  financial  an  security,  to  reflect  examine  if  attributes this  firms  and  should  not  73 that  not  to  be  a  serious concern.  use  of  at  the  any  measure  However,  stock  As the  /  the  year-end  accounting  time  issue  month  after  financial  little can be  of  the  position  done  to  figures  is  in  principle  end  of  the  of  do  not  the  financial  appropriate.  accounting year.  the  firm  may  be  away  with  this  data  characteristics  Some  issues  Using year-end  out-of-date  for  some  inaccuracy problem.  may  figures issues.  X.  This  paper  include the  the  study  financial to  (1982)  decision  to  issue  preferred  firms  that  In  addition,  to  the  issue  and  common  probability  and  stock  equity,  preferred the  of  avoid  the  difference  states  incentive  Apparently  the  problems  general  lack  preferred  subject. about  that  The the  stock, results,  into  seem  the  solution stock  market  can  explaining  bonds,  and  common  though  not  entirely  opportunities  show  stock.  Finally,  stock.  partial  are  more  investment to  support likely  to  opportunities  book  debt  value  of  incentives  eliminate  the  financing.  warrants  conclusive,  that when  determinants  stock  likely  stock  and  used  and  more  hand, firms  growth  adverse  the  are  lend  The  be  distinct  preferred  to  value  equity  in  firms  to  some  common over  to  stock,  preferred  growth  bankruptcy.  the  74  other  distressed firms  of  the  the  c o m m o n stock  success  characteristics of  liquid  choice  preferred  carry  less  vis-a-vis  logit  on  do  issue  with greater  caused by c o m m o n  of  to  debt-equity  focus  and  likely  financially  preferred  a  bonds. 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Rate  APPENDIX  Distributions Variable  Variable  of  Variables  Name  Used  Mean  I  in  the  Univariate Median  Analysis Standard Deviation  Deviation Target  -0.02  -0.04  0.53  SIZE1  6.87  6.99  1.49  SIZE2  6.75  6.79  1.51  Asset Composition  ASSCOM  0.57  0.57  0.24  Bankruptcy  RISK1  -2.60  -2.52  1.47  RISK2 RISK3  0.03 0.44  0.03 0.21  0.03 0.83  EFFTAX  0.44  0.46  0.29  GROW1  0.25  0.06  0.58  GROVV2  0.18  0.12  0.27  Profitability  PROF1 PROF2  0.19 0.07  0.16 0.07  0.12 0.03  Liquidity  LIQ1  1.63  1.50  0.79  LIQ2  0.14  0.10  0.16  Preferred Stock Issue Forecast  PFDVOL  5.81  5.73  0.42  Bond Issue Forecast Common Stock Issue Forecast  BONVOL  8.38  8.20  0.76  COMVOL  7.39  7.42  0.68  Size  of  from  Firm  Risk  Effective Rate  Tax  Growth Opportunities  DEV  84  


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