| Capital structure theory and empirical analysis has focused almost exclusively on the choice between debt and equity. Preferred stock has received relatively little attention, in contrast, even though the U.S. market represented 868 billion dollars in new capital during the time period 1999 to 2005. This empirical study focuses on the reactions of equity holders through an event study analysis and of debt holders through a default spread analysis to the announcement of 427 preferred issues. This study finds that the equity abnormal announcement returns are positive for straight preferred stock announcements, when they are combined with convertible preferred announcements, the equity abnormal returns are much closer to zero than to the magnitude of secondary equity offering announcements; furthermore, these returns are higher for firms with greater earnings potential and lower financial distress risk. This study also finds that credit default swap spreads decrease upon announcement of a preferred issue. These results are consistent with the hypothesis that equity holders interpret the preferred issue, on average, as debt, since the magnitude of the usual negative reaction to seasoned equity issuance is not found and bondholders interpret the preferred issue as equity, since the issuance does not increase the firm's default risk. |
