Financial innovations and excesses revisited: the case of auction rate preferred stock - Security Design Special Issue

Financial Management (Financial Management Association), Summer, 1993 by Michael J. Alderson, Donald R. Fraser

II. Empirical Analysis

A. Data and Sample Selection

The Dutch Auction Rate Preferred Stock History Quarterly, published by Salomon Brothers, served as the point of origin for the empirical analysis. An assortment of documents published between March 1988 and March 1991 were used to identify 103 firms that issued at least one series of publicly traded auction rate preferred stock between the third quarter of 1984 through the first quarter of 1991. The same quarterly histories also reported the names of companies that have redeemed at least one series of auction rate preferred, along with the respective series of shares and associated redemption dates.

Each issue of the DARPS Quarterly also contains all or part of the time-series of auction dates and dividend yields for each issue outstanding at the publication date, along with the ratio of each dividend yield to the contemporaneous 60-day AA commercial paper rate (hereafter CP percentage). From the assortment of documents available, we were able to identify the dividend yield and CP percentage for each issue at the time of the initial offering. Because the time-series of quarterly histories was uniformly distributed over the 1984-1991 period, it was also possible to reconstruct at least a portion of the time series of dividend yields for each issue. For the subsample of companies that redeemed their auction rate preferred shares, this time-series provided the last available dividend yield and associated CP percentage prior to the redemption date. It also served as the source for the dividend yields resulting for the latest available auction for each respective company that had not redeemed its issues as of the end of the first quarter of 1991. Separately, industry classifications, parent-subsidiary relationships and the identity of limited-purpose subsidiary issues were also obtained for each issue by searching the Moody's Bond Survey and the Compact Disclosure Data Base.

Exhibit 2 summarizes select attributes of issue and redemption activity by year in the market for auction rate preferred stock over the period spanning the third quarter of 1984 through the first quarter of 1991. The reversal in new issue activity is evident from Panel A of the exhibit. Over the first three full calendar years (1985-1987) of its existence, $13 billion of auction rate preferred stock was TABULAR DATA OMITTED issued by 73 companies, with over one-half (38) originating from limited-purpose finance subsidiaries. In contrast, less than $5 billion of DARPS was issued in the last three full years (1988-1990) by 25 companies, only one of which was a limited-purpose subsidiary.

Consistent with the findings of Linn and Pinegar |8~, the population of auction rate issues displays a strong concentration of firms in the financial sector. A breakdown of the 103 issuing companies by industry classification in Panel B shows that fully one-half of the companies issuing auction rate preferred stock were either banks, thrifts or credit companies; the remaining portion of the sample was split evenly between nonbank financial institutions, industrial companies and utilities.