We analyze the optimal mix of debt, common equity, and preferred equity in a model with an investment opportunity and asymmetric information about its quality, and show that an all-equity financed firm will overinvest. Issuing the appropriate amount of debt before the project becomes available resolves this overinvestment problem. Introducing a second motive for debt, such as taxes, leads to a role for preferred stock as a means of enhancing the firm's “debt capacity,” by creating additional incentives to invest. We derive an optimal capital structure involving debt, preferred stock, and common stock.

The Role of Debt and Perferred Stock as a Solution to Adverse Investment Incentives

La complejidad del mundo empresarial, unida a la globalizacion de las actividades economicas y el desarrollo de las nuevas tecnologias, tanto en los procesos productivos como en los medios de intercambio comercial y de capitales, condicionan las decisiones de los usuarios de la informacion contable. En este contexto, el modelo contable actual esta siendo criticado, ya que no evoluciona al mismo ritmo que las operaciones economicas. Este hecho situa a la contabilidad normalizada en una etapa de cambios en la que los legisladores publicos y organismos contables privados proponen modificaciones en las estructuras y objetivos de la divulgacion para mejorar su utilidad. Esta investigacion recoge los aspectos en los que se orienta la investigacion actual, elaborando un nuevo Marco Conceptual fundamentado en un analisis detallado del entorno que tenga como objetivo la satisfaccion prioritaria de las necesidades de los inversores y el incremento de la comparabilidad de las normas. Para ello su estructura recoge informacion previsional y no financiera que permita superar las limitaciones del modelo actual para reconocer el Capital Intelectual, lo que de otra forma impediria reflejar el valor de determinadas inversiones y dificultaria la consideracion de las actividades de innovacion como variables estrategicas; ademas establece los criterios para poder registrar adecuadamente las fuentes de financiacion situadas entre los recursos propios y ajenos, que en la actualidad tienen una importancia creciente.La elaboracion de la Propuesta de Marco Conceptual se completa con la valoracion de las posibles utilidades y un analisis de las partidas que mejorarian con su aplicacion. El trabajo es fundamentalmente deductivo, pero intenta acercarse al analisis de la realidad con un detallado analisis del entorno y de la legislacion contable actual para reducir el gap existente entre ambos. La informacion descriptiva se completa con dos estudios empiricos, uno de las acciones privilegiadas emitidas y otro de la informacion del Capital Intelectual que revelan voluntariamente las empresas.

Posibles soluciones a problemas de la normalización contable

N Significant changes occurred in the market for preferred stock during the 1980s. The most apparent change was the number of new types of preferred stock. These innovations, including various types of adjustable rate and auction rate preferred stock, have received considerable attention in the business and academic press (see, for example, Alderson, Brown, and Lummer [1], Finnerty [12], and Winger et al. [25]). However, because of fundamental economic developments during the 1980s, there is good reason to believe that the changes go far beyond the innovations in preferred stock instruments. The 1980s witnessed a highly active merger market and turbulence and regulatory change in the financial services industry that is unprecedented since the Great Depression. Also important are the recent downturn in capital expenditures by the utility industry and changes in the tax laws. Taken together, these factors have produced major shifts in the pattern of industry issuances of preferred stock. The theory of preferred stock-how preferred stock fits into the capital structure framework-has also undergone considerable development in the past few years. Fooladi and Roberts [13] integrate preferred stock into Miller's [18] "Debt and Taxes" framework. Because preferred stock is a tax-advantaged investment for corporate investors, positive amounts of preferred stock will be both supplied and demanded in a Miller equilibrium. Elmer [10] integrates the Miller equilibrium model with the tax shield uncertainty model of DeAngelo and Masulis [9]. He demonstrates how preferred stock interacts with nondebt tax shields to influence a firm's optimal capital structure, showing that low preferred stock yields effectively enable low tax rate firms to sell excess tax shields. In this way, firms can effectively achieve tax advantages similar to debt financing regardless of their present and expected tax This paper has benefitted from a workshop presentation at San Diego State as well as from helpful comments from Keith Brown, Robert Capettini, Gun-Ho Joh, Nikhil Varaiya, three anonymous reviewers, and the editor. An earlier version of this paper was presented at the FMA meeting in 1988. We are grateful for the support of the Price Waterhouse Foundation. The authors would like to thank Airung Liu for her valuable research assistance.

http://www.jstor.org/stable/pdfplus/10.2307/3665824.pdf

Financing with Preferred Stock

During the 1960's warrants to purchase common shares were attached to the debt and equity securities of an increasing number of corporations in order to facilitate the sale or exchange of these securi­ ties. These warrants presented a potential problem to investors who purchased common shares of the issuing corporations. The exercise of these warrants could result in the dilution of the corporations' book value per share, their earnings per share, and the market value of their shares as well as the voting power of the in­ dividual stockholders. In May, 1969 the American Institute of Certified Public Accountants (through the issuance of APB Opinion No. 15) adopted the treasury stock method for reflecting the potentially dilutive effect of warrants on earnings per share. On a theoretical basis the. treasury stock method has certain disadvantages. Although the treasury stock method makes no specific assumptions about the rate of return earned on warrant proceeds, the use of this method results in an earnings rate on warrant proceeds which is less than the earnings-price ratio of the corporation. Such a rate is unrealistically low for corporations with high price-earnings ratios and perhaps overly optimistic for corporations with low price-earnings ratios. In addition, the treasury stock method causes the earnings per share of corporations with warrants outstanding to vary inversely with the price of the corporations' common stock. This study evaluates, on a theoretical basis, several methods of reflecting the potential dilution of warrants in the earnings-per-share xiii computations. The desirability of including the potentially dilutive effect of warrants in both primary and fully diluted earnings per share is also considered. Guidelines for the evaluation of the various methods of reflecting the potential dilution of warrants in the earnings-pershare computations are developed through an analysis of: (1) the attri­ butes of earnings per share that investors perceive to be useful in the evaluation of common stocks, (2) the characteristics of warrants which might affect earnings per share, and (3) the problems encountered by the Accounting Principles Board in arriving at an acceptable method for handling warrants. This thesis includes an in-depth study of the accounting, finance, and investment literature related to warrants and earnings per share as well as an intensive examination of the earnings-per-share files of the Accounting Principles Board of the American Institute of Certified Public Accountants. In addition, an analysis was made of the characteristics of warrants listed on the American Stock Exchange between 1950 and 1972. This study concludes that a minimum of two earnings-per-share figures for companies with warrants outstanding should be provided to investors. These are: (1) earnings per average common share which ex­ cludes the potentially dilutive effect of warrants and (2) fully diluted earnings per share which includes an estimate of the potential dilution of earnings per share which might occur through the exercise of warrants. This study further concludes that the most appropriate method of reflecting the potentially dilutive effect of warrants in fully diluted earnings per share is the operating rate of return method. This method assumes that the investment of the warrant proceeds will provide a return equal to the current rate of return on assets.

A Theoretical Study of the Effect of Various Assumptions Regarding the Use of Warrant Proceeds on Earnings-Per-Share Computations.

Introduction. Part I: Regulatory Issues of Hybrid Financial Instruments: The Classification Approach. 1. A Historical Perspective. 2. Distinguishing between Equity and Debt. 3. Setting the Theoretical Background. Part II: Governance Regulation of Hybrid Financial Instruments: The Functional Approach. 4. From the Classification to the Functional Approach. 5. Significant Corporate Decisions. 6. Financing through Hybrid Instruments: Risks of Opportunism and Legal Strategies for Mitigation. 7. Control Transactions. 8. Conclusive Considerations. Bibliography.

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H ElsaidHussein

Papers

The Function of Preferred Stock in the Corporate Financial Plan