Although financial instruments that, in effect, permit corporations to treat preferred stock dividends as tax-deductible interest have been used by nonfinancial corporations since late 1993, bank holding companies (BHCs) did not issue these trust-preferred securities (TPS) until 1996, when the Federal Reserve qualified them as Tier-1 capital. We delineate and test hypotheses with 1) analyses of the stock-market reaction to the Fed’s ruling and to TPS filings and 2) comparisons of BHCs that issued TPS with those that did not. We conclude that regulatory capital requirements, tax savings, and uninsured sources of funds can have significant positive effects on BHCs’ demand for capital; growth and investment opportunities have an inconclusive effect; and transaction costs have a negative effect. Our results are not consistent with the moral-hazard hypothesis.
JEL classification: E5, G2, L1, L5
Key words: bank capital structure, bank holding companies, regulatory capital, securities innovations, Tier-1 capital, trust-preferred securities
The authors thank Michael Padhi of the Federal Reserve Bank of Atlanta for his assistance in obtaining financial data for bank holding companies; Christopher Gastelu of Ryan, Beck & Co., Livingston, New Jersey, for providing data on trust-preferred transactions by community banks and thrift institutions; John Connolly, Robert Eisenbeis, Jocelyn Evans, Ramon DeGennaro, George Kaufman, George Selgin, Steve Smith, Richard Stehle, and Larry Wall for their comments; and Elaine Dunbar, University of Georgia, and Denise West, Emory University, for their assistance. Earlier versions of this paper were presented at Humboldt University, Berlin, Germany, and the Federal Reserve Bank of Atlanta. During part of his research, Sinkey was a visiting scholar at the Federal Reserve Bank of Atlanta. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.
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