THE ROLE OF PREFERRED STOCK IN ELECTRIC UTILITY FINANCING*

Abstract

THIS STUDY UTILIZES the electric utility industry to probe the waning popularity of nonconvertible preferred stock. This industry was selected because it is responsible for one in every three nonconvertible preferred issues marketed over the study period (1950-62). The purpose is to gauge the signs of deemphasis, analyze underlying forces, and evaluate the future role of the security. Data presented and analyzed reflect the declining portion of electric utility capital being raised via preferred stock. Detailed evidence is presented on new issues, refundings, redemption activity, and divestments. On the basis of aggregate data for Classes A and B electric utilities and a study of a core group of 150 companies it was found that a declining trend in preferred stock as a per cent of capitalization exists and is mainly the result of a fall in new offerings. A study of nonconvertible preferred stock contracts (305) indicates a high degree of uniformity which is largely the result of SEC influences under the Holding Company Act of 1935. In general, these issues of preferred stock have cumulative dividend and liquidation preference over common stock and are callable. In the majority of cases contingent voting privileges are given to elect directors upon dividend defaults. Preemptive and participation rights are not present. The low incidence of redemption funds and the frequency of extended retirement periods leads to the conclusion that electric utility straight preferred stocks are generally regarded as permanent capital. A questionnaire-survey of the core group probed a variety of areas, mainly related to forces leading to the lull in preferred stock sales over the past decade. On the basis of the results and extensive examination of the literature, it was concluded that structural shifts in financing are the prime source of deemphasis. The trend of financing reveals a greater reliance upon internally generated funds. The external financing that has been undertaken has been principally in the form of long-term debt. This has been facilitated by somewhat higher debt ratios permitted by regulatory and rating agencies, the cushioning effect of internally generated funds on debt percentages, and the rising levels of federal taxes on corporate income. External equity financing was primarily in the form of common stock. The bullish nature of the market for common stock has permitted many utilities to sell these securities at high price-earnings ratios with little or no dilution. Preferred stock has proven less attractive relative to other means of external financing. A comparison of the assumed role of nonconvertible preferred stock and its role in practice indicates close correlation. In essence the function of the security is to keep debt and equity ratios in line as a compromise vehicle in terms of safety, cost, and flexibility in financing. Moreover, the use of preferred stock carries with it a degree of secondary leverage and when markets are unfavorable for common stock or when dilution of earnings per share is apparent, preferred stock assumes a place in financial planning. An analysis of the practical advantages of substituting