The Offer Yield of Preferred Stocks

Abstract

Despite the growing popularity of preferred stocks, no previous study has empirically examined their offer yields relative to comparable bonds. Like debt preferred stocks also offer a constant yield to investors. But preferred stocks have longer durations than bonds and are also subordinate to bonds. Hence, preferred stocks are generally riskier than bonds. This "risk effect" is likely to increase preferred stocks' offer yield relative to bonds. However, preferred stock dividends are often tax-deductible to the corporate investor. This tax benefit offsets the risk effect. We empirically examine the net impact on the yield differential between preferred stocks and bonds by considering "matched pairs" of these securities issued between January, 1982 and September 2000. We find that the risk effect dominates the tax effect for financial firms and risky issuers while the tax effect dominates for utilities and highly rated issues.