ON PREFERRED STOCK

Preferred stock is issued by many corporations in spite of its apparent disadvantages. This study explains why. A simple partial equilibrium model is presented in which preferred shares are both supplied and demanded. Stronger tax incentives in Canada than in the United States may create a positive preferred equilibrium. Empirical evidence on the relative use of preferred stock in the two countries is presented to support this hypothesis.     

THE ANNOUNCEMENT EFFECTS OF PREFERRED STOCK RE-RATINGS

This paper examines the equity return behavior of firms whose preferred stock ratings have been changed by Standard and Poor's. The evidence indicates that the market anticipates the re-ratings by approximately 40 days for the complete sample. However, the downgrades for the utility subsample do not experience any downward drift before or after the re-rating. In general, these results support the previous findings of Pinches and Singleton (1978) and Weinstein (1977).     

PREFERRED STOCK ARBITRAGE OF MUNICIPAL BOND MARKET SEGMENTATION

This paper discusses how tax and regulatory constraints in the municipal bond market can affect preferred stock yields and give rise to arbitrage opportunities in the preferred stock market. The potential for profit is illustrated with an example that also serves to highlight the unique characteristics of recently developed forms of preferred stock.     

HEDGING FIXED-RATE PREFERRED STOCK INVESTMENTS

Corporations seeking to maximize the return on their cash reserve resources have an incentive to invest in traditional preferred stock because of their right to exclude 70% of the dividends from taxation. Nevertheless, fixed-rate preferred stock investments may contribute significantly to the return volatility of a cash portfolio and cause unacceptable losses to the corporate investors. As a result, many corporations might consider such higher-return investments only if they can hedge away a sufficient amount of risk. The research presented in this article seeks to evaluate how much of the return variation of fixed-rate preferred equity portfolios can be reduced with various hedging strategies.
This research shows that it is possible to reduce the risk of preferred stock investments significantly through the use of hedges employing some combination of fixed income futures and/or options. Although some risk remains even with the hedged preferred stock portfolio, the author demonstrates that money market assets can be combined with a hedged preferred stock portfolio to create a position that has no material chance of loss but expected after-tax returns higher than those on money market investments. In addition, the article also shows the high level of profitability associated with a strategy of increasing the size of liquid reserves in order to allow for losses related to an unhedged preferred stock component of those reserves.     

VALUATION OF THE PREFERRED STOCK SINKING FUND FEATURE: A TIME-SERIES APPROACH

This study employs a time-varying coefficient model to examine the relationship between returns on preferred stock with a sinking fund and preferred stock without a sinking fund. The results provide evidence of a major shift in the relationship between the two types of preferred stock coincident to a major change in Federal Reserve Board monetary policy. Results also show several smaller shifts at other times. The findings lend only weak support to link the announcement of a change in bookkeeping practices for insurance companies with a contemporaneous change in the relationship between the two types of preferred issues, as previous studies contended.     

AN INVESTIGATION OF PREFERRED STOCK FINANCING BY BANK AND NONBANK FINANCIAL INSTITUTIONS

We investigate the shareholder wealth effects of announcements of preferred stock issues made by financial institutions. Fixed-rate straight preferred stock and convertible preferred stock issue announcements result in insignificant common share price responses. However, the average stock price reaction to announcements of adjustable-rate preferred stock issues is positive and significant for banking firms. Our findings suggest that banks' common shareholders react positively to adjustable-rate preferred stock issue announcements because such securities provide a relatively low-cost way of increasing the primary capital used to satisfy legal minimum capital requirements without diluting common equity voting rights.     

EVIDENCE ON THE ROLE OF TAXES ON FINANCING CHOICE: CONSIDERATION OF MANDATORILY REDEEMABLE PREFERRED STOCK

In this study we examine the effect of firms' marginal tax rates on incremental and overall reliance on mandatorily redeemable preferred stock (MRPS). Similarities in the cash flows associated with debt and MRPS, as well as similarities in the claims of holders of debt and MRPS on the assets of issuing firms, suggest that MRPS may be viewed as a substitute for debt. However, important differences in the tax treatment of MRPS and debt suggest that firms that cannot make full use of interest tax shields may be able to finance more efficiently using MRPS instead of debt. The results indicate that, both incrementally and overall, firms with low marginal tax rates rely more heavily on MRPS than debt relative to firms with high tax rates. This finding is consistent with the proposition that firms that cannot make full use of interest tax shields finance incrementally using equity rather than debt.