The adverse-selection hypothesis implies that conventional convertible preferred stocks should be called earlier than convertible exchangeable preferred stocks.
Convertible exchangeable preferred stocks make up the majority of the sample offerings in 1985-1989, while conventional convertible preferred stocks predominate in other years.
Table 2, Panel B reports that the mean dividend yield on convertible exchangeable preferred stocks is 8.4% (median 8.0%) and the mean and median yield on convertible preferred stocks is 9.0%.
Panel B also reports that the investors' mean yield gain from immediate conversion is -7.3% (median - 7.0%) of the offering price for convertible exchangeable preferred issues and -7.9% (median -8.0%) for convertible preferred stocks. However, holders will not exercise their option to convert into common stock as long as the option is out of the money.
Because of a few immediately callable issues, the mean for convertible preferred stocks is 121 days, but the median is 1088 days.
Convertible exchangeable preferred stock is a variant of convertible preferred stock that first appeared in 1982.
Also under the adverse-selection hypothesis, the common stock-price reaction to a convertible exchangeable preferred stock offering should be more negative than the reaction to a convertible preferred stock offering.
Convertible Preferred Stock Versus Other Securities
The focus of this paper is the choice between conventional and exchangeable forms of convertible preferred stock. First, however, it is useful to consider why a firm would issue convertible preferred stock in any form.
In the absence of taxes, convertible preferred stock would be roughly equivalent to convertible debt.
In summary, the unique properties of convertible preferred stock allow issuers that face low tax rates to reduce the costs of agency problems or estimation risk while benefiting from the tax treatment of intercorporate dividends.
Exchangeable Versus Non-Exchangeable Convertible Preferred Stock