Taxes and the Choice of Issuing Preferred Stock vs. Debt

Abstract

This study provides descriptive evidence on the link between a firm's expected marginal tax rate and its use of preferred stock as an alternative to financing with long-term debt. Regressions are estimated on a sample of industrial firms that issued preferred stock and a control group, matched on industry and size, that contemporaneously issued long-term debt. Substantial tax effects are found for a full sample of firms that issued any type of preferred stock, as well as a large subsample that issued only convertible preferred stock, frequently used to facilitate mergers and acquisitions. For the typical firm, a decrease in its expected marginal tax rate from the 75th to the 25th percentile is associated with a 33 percent increase in the likelihood it will issue preferred stock. This financing behavior is consistent with a goal of enhancing tax benefits.