Panel C of Exhibit 2 details the extent of redemption activity in the market for publicly traded auction rate preferred stock. The first redemptions occurred in 1987 when three companies exercised the call feature of their respective issues.
Under the tax laws in effect in 1984, interest on commercial paper was taxed at a rate of 46% and dividends on auction rate preferred stock were taxed at an effective rate of 6.9% (reflecting the fact that only 15% of dividends received were subject to taxation at the corporate level).
Exhibit 3 contains the results from the logit regressions relating firm characteristics to the decision to redeem an TABULAR DATA OMITTED issue of auction rate preferred stock. For each model, the coefficient estimates from the logit regression are displayed along with their respective asymptotic (large sample) p-values, the p-value for the model and the pseudo R-square measure (which is based upon the differences between the actual frequencies in each subgroup and the estimated frequencies obtained from the regression model).
The dummy variable was assigned a value of one if Moody's Bond Survey or other sources of information such as the Wall Street Journal indicated that the shares were issued by a bankruptcy-remote, limited-purpose subsidiary created specifically for the purpose of issuing auction rate preferred stock. Separate consideration of the limited-purpose subsidiary issues was necessitated by the fact that their collateralized structure generally commanded a lower dividend yield than comparable (Aaa-rated) non-credit-enhanced issues.
The set of tests reported here seek to determine whether the risk profile of firms that first issued auction rate preferred stock differ from the risk profile of companies that have sold shares more recently.
To obtain additional perspective on the factors influencing redemption activity in the market for auction rate preferred stock, a mail survey was sent in July 1991 (and a follow-up survey in September 1991) to the corporate treasurer of each of the firms in our sample that redeemed an issue of auction rate preferred stock prior to that time.
Questions 3 and 4 sought to determine the extent to which the decision to redeem was influenced by firm-specific factors that would influence the relative cost of auction rate preferred stock financing.
Auction rate preferred stock appears to offer a significant financing advantage relative to fixed rate preferreds, yet the size of the auction rate market has contracted since 1987.
The design features of auction rate preferred stock suggest an exclusive suitability for transferring capital from fully taxable, risk-averse cash managers to low-risk corporations with low marginal tax rates.