Preferred stock issuance in the restaurant industry and financial distress

Abstract

ABSTRACT The purpose of this study is to offer insights into why restaurant firms issue preferred stock despite the disadvantage of using preferred stock as compared to debt. This disadvantage is due to the fact that debt interest payments but not preferred stock dividends provide tax-deductible savings for the issuing firm. We empirically examine the proposition that restaurant firms issuing preferred stock are more financially distressed than non-issuing firms. Specifically, we analyze five financial ratios that are related to financial distress. They are debt ratio, retained earnings to total assets, times interest earned, net profit margin, and return on assets. Data from 56 restaurant firms issuing preferred stock between 1980 and 2016 were compared to a control group of non-issuing restaurant firms. Results from the multivariate analysis of variance lend robust support to the financial distress explanation as well as other explanations. We believe this is the first analysis of the usage of preferred stock by restaurant companies. Our findings should be a significant consideration for restaurant firms contemplating the issue of preferred stock and also an important consideration for potential investors in these firms.