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Debt Covenants, Balance Sheet Classification, and the Effects of FAS150: Evidence from Trust Preferred Stock
William Moser, University of Missouri
Kaye J Newberry, University of Houston
ABSTRACT. Trust preferred stock was created to provide mezzanine reporting on the financial balance sheet and debt treatment on the tax return. We construct a 12-year panel of large companies to relate their trust preferred stock usage to their bank debt contracts and the passage of FAS150. Prior to mandated liability classification under FAS150, we find that firms subject to financial covenants and higher renegotiation costs are more likely to use the proceeds of new issuances to enhance their balance sheets by retiring debt. We also find that firms’ holdings of trust preferred stock relate positively to whether they are subject to financial covenants or performance pricing agreements. Finally, we find that firms who originally used the proceeds to take advantage of mezzanine reporting by retiring debt, or whose current loan provisions impose financial covenants are significantly more likely to redeem their trust preferred stock after FAS150 became effective.
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