Bank Capital Structure, Regulatory Capital, and Securities Innovations

Since late 1993, nonfinancial corporations have used financial instruments that permit them to treat preferred-stock dividends as tax-deductible interest. Bank holding companies (BHCs), however, did not issue these trust-preferred securities (TPS) until 1996, when the Federal Reserve qualified them as Tier-1 capital. We delineate and test five, not mutually exclusive, hypotheses by: (1) analyzing the stock-market's reaction to the Fed's ruling and to TPS filings and (2) comparing BHCs that issued TPS with those that did not. We find that regulatory capital requirements, tax savings, and uninsured sources of funds had significant positive effects on BHCs' demand for capital and that the market responded favorably to TPS filings. Our event-study findings are contrary to prior empirical results in that we find a positive market reaction to equity offerings.