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Bank debt covenants and rms responses to FAS 150

liability recognition: evidence from trust preferred


stock
William Moser

Kaye Newberry

Andy Puckett
Published online: 25 March 2011
Springer Science+Business Media, LLC 2011
Abstract We examine the relation between accounting-based debt contracts and
the economic response of rms with trust preferred stock (TPS) to mandated lia-
bility recognition under Financial Accounting Standard (FAS) 150. Our results
show that rms nancial covenants signicantly affect their choice to redeem
versus reclassify their outstanding TPS. Specically, rms with bank debt covenants
that would be adversely impacted by recognizing TPS as a debt liability are 26.88%
more likely to redeem their TPS after FAS 150. We also nd that rms are sig-
nicantly more likely to redeem versus reclassify their TPS after FAS 150 if they
used the original TPS proceeds to retire existing debt (id est, to enhance their
balance sheets). Our ndings suggest that when bank debt contracts use oating
Generally Accepted Accounting Principles (GAAP) to construct nancial covenant
terms, changes in the underlying GAAP measure signicantly inuence rms
economic behavior.
Keywords Bank debt Debt covenants Trust preferred stock FAS 150
JEL Classications G21 G32 K12 M40
W. Moser (&)
Trulaske College of Business, University of Missouri, 432 Cornell Hall, Columbia, MO 65211, USA
e-mail: moserwj@missouri.edu
K. Newberry
C.T. Bauer College of Business, University of Houston, 360D Melcher Hall, Houston,
TX 77204, USA
e-mail: kjnewberry@uh.edu
A. Puckett
College of Business, 437 Stokely Management Center, University of Tennessee, Knoxville,
TN 37996, USA
e-mail: pucketta@utk.edu
1 3
Rev Account Stud (2011) 16:355376
DOI 10.1007/s11142-011-9143-x
1 Introduction
We examine the association between nancial debt covenants and the economic
responses of rms with trust preferred stock (TPS) to mandated liability recognition
under FAS 150. As Fields et al. (2001) discuss, imperfections associated with
incomplete markets provide demand for accounting-based contractual agreements.
As such, assessing the role of accounting information in nancial contracts is of
primary importance. Bank debt agreements typically include nancial covenants
that, when violated, allow lenders to renegotiate the terms of the contract or
intervene in the decisions of managers or both.
1
Dichev and Skinner (2002) nd that
nancial covenants are set tightly so that they act as early warning tripwires that
trigger lender rights. Thus even rms that are not nancially distressed are at risk of
violating covenants and being subjected to increased lender scrutiny. Beatty et al.
(2002) nd that rms are willing to pay substantially higher interest rates to retain
accounting exibility that might help them to avoid covenant violations. However,
empirical evidence has remained largely inconclusive on the relation between debt
covenants and nancial reporting choices.
2
The passage of FAS 150 in 2003 provides a natural experiment to investigate the
relation between debt contracting and nancial reporting choices. Under FAS 150,
rms are required to recognize certain hybrid securities that previously qualied for
mezzanine reporting on the balance sheet as debt liabilities. This mandatory liability
recognition has the potential to adversely affect rms nancial debt covenants. We
contribute to the literature by examining the economic responses of rms with
outstanding shares of a popular hybrid security (TPS) following the passage of FAS
150.
3
Trust preferred stock is particularly relevant for our tests because it is a debt-like
security developed to exploit pre-FAS 150 book-tax differences in the treatment of
special purpose entities. Before FAS 150, TPS was treated as debt for tax purposes
and as mezzanine nancing for nancial accounting purposes. Our ndings suggest
that rms whose bank debt covenants were affected by FAS 150 were more likely to
redeem their TPS after its passage. Because redemption decisions are costly, our
results have implications for nancial contracting and its affect on shareholder
wealth.
4
It is not clear, ex ante, whether reporting classications should affect rms TPS
redemption decisions. There is a debate regarding the role that banks play as users
of nancial statement information. One view is that banks are less susceptible to
1
Given this contractual use of accounting numbers, Ball et al. (2008) hypothesize and nd evidence of
debt markets creating a demand for nancial reporting.
2
Fields et al. (2001), Dichev and Skinner (2002), and Beatty and Weber (2003) provide discussions of
the inconclusive nature of empirical evidence on reporting choices.
3
Early versions of the securities relied on limited liability companies (LLCs) as issuing entities but,
beginning in 1995, subsidiary trusts emerged as the special purpose entity of choice. Thus trust preferred
stock came into use as a common descriptor for the entire group of debt-equity securities.
4
In addition to the standard (e.g., investment banking) costs that are associated with redeeming TPS, we
nd eight redeeming rms that paid a call premium to redeem their TPS shares. The average call premium
was 101.625%, or $7 million, and ranged from 100.625 to 104.25%.
356 W. Moser et al.
1 3
biases in nancial reporting since they can obtain information as a condition of
completing a transaction and proscribe bias-reducing contracts (Guay and Verrec-
chia 2006). Under this view, the reporting classication for TPS is unlikely to affect
rms debt covenants (or, by implication, their responses to FAS 150) because the
treatment of particular securities can be specied in the debt contract. An alternate
view is that changes in nancial reporting do affect lenders performance
assessments via nancial covenants because banks primarily contract on oating
Generally Accepted Accounting Principles (GAAP) (for example, Holthausen and
Watts 2001; Watts 2003; Ball et al. 2008).
5
Our rst prediction is that rms whose bank debt covenants are adversely
affected by the mandated reclassication of TPS as a debt liability under FAS 150
are more likely to redeem their TPS. To test this hypothesis, we rst identify a
sample of rms with outstanding TPS and then collect actual debt contracts for all
of our sample rms both before and after the passage of FAS 150. If the debt
contracts use oating GAAP as the basis for dening nancial covenants with
debt or interest terms, then the FAS 150 mandated recognition of TPS as a debt
liability increases the probability of technical violation.
6
However, if the loan
agreements dene debt or interest terms using xed GAAP or specify the same
classication of TPS both before and after the passage of FAS 150, then there
should be no adverse effects. These rms should be less likely to redeem their TPS
shares (id est, more willing to reclassify their outstanding TPS as debt on their
balance sheets).
Our second prediction draws on rms original purpose for raising capital with
TPS. If a rm wanted to enhance its balance sheet, it could issue new TPS to retire
existing debt. By doing this a rm could, in effect, reclassify debt liabilities to the
mezzanine section of the balance sheet (between liabilities and equity).
7
In contrast,
if a rm wanted to take full advantage of the TPSs attractive tax features, the
original issue proceeds could be used to retire traditional preferred stock or common
stock (both with nondeductible dividend payments). Such usage would not enhance
the balance sheet because the TPS would merely replace an existing form of equity.
Our second hypothesis tests the prediction that rms that used the proceeds of the
original TPS issuance to retire existing debt are more likely to redeem TPS shares
after the passage of FAS 150.
Time series data are consistent with our sample rms redeeming their outstanding
TPS after the passage of FAS 150. Figure 1 presents data on the aggregate
outstanding TPS holdings of our sample rms from the initial introduction of TPS in
5
Floating GAAP refers to the use of current accounting rules to dene nancial terms, such that the
denition of nancial terms changes along with subsequent accounting rule changes. Alternatively,
xed GAAP refers to the use of the specic GAAP rules that are in place when the contract is signed.
Under xed GAAP, the denition of nancial terms does not change with subsequent accounting rules
changes.
6
Several potential advantages of using oating GAAP include that it is less costly to monitor and that
it imposes fewer restrictions on corporate activities (see Smith and Warner 1979; Holthausen and
Leftwich 1983; Watts and Zimmerman 1986).
7
This reclassication as quasi-equity was not without some merit given some of the common features of
TPS, such as its long maturity term and allowance for deferred interest payments in the event of nancial
distress.
Bank debt covenants and rms responses to FAS 150 liability recognition 357
1 3
1993 through 2005. This gure shows a dramatic decline of $15 billion (or an
approximate 60% reduction) in TPS holdings during the 2003 to 2005 post-FAS 150
period. Thus Fig. 1 provides initial evidence suggesting that the liability reporting
requirements of FAS 150 made TPS less attractive after 2003.
Our univariate and multivariate test results are also consistent with both of our
predictions regarding the characteristics of rms that are more likely to redeem their
TPS in the post-FAS 150 time period (2003 through 2005). For our rst prediction,
we nd that rms are signicantly more likely to redeem (versus reclassify) their
TPS after FAS 150 if they have bank debt covenants that would be adversely
impacted by recognizing their TPS as a debt liability. Elasticity estimates further
suggest that the probability of redeeming TPS increases by 26.88% for rms with
affected covenants. For our second prediction, we nd that rms are signicantly
more likely to redeem (versus reclassify) their TPS after FAS 150 if they used the
original TPS proceeds to retire existing debt. Elasticity estimates for this measure
suggest that the probability of redeeming TPS increases by 22.35% for these rms.
We supplement our empirical tests with descriptive data on the method of
redemption for those sample rms that redeemed TPS shares in the post-FAS 150
period. We nd that approximately half of the TPS redemptions are funded by the
issuance of common stock or by exercising conversion features that allow
conversion to common stock. Only one rm specically renanced its TPS through
new debt issuances. These data are also suggestive of rms avoiding liability
recognition as a rst-order determinant of their decisions to redeem TPS.
Our study provides new insights regarding the role of accounting information in
debt contracts and implications for mandated accounting changes and balance sheet
classication standards. First, our ndings suggest that, when bank debt contracts
Fig. 1 Trust preferred stock. The gure reports the time series of outstanding trust preferred stock for all
industrial rms during the 1993 through 2005 sample period. We report the appropriate gures for all
industrial rms and for three subcategories of rms that are classied according to how the rm used the
proceeds of the original trust preferred stock issue
358 W. Moser et al.
1 3
rely on oating GAAP to construct nancial covenant terms, changes in the
underlying GAAP measures can signicantly inuence rms economic behavior.
In our setting, that translates into a greater likelihood of redeeming (id est,
renancing) a nancial security that is subject to mandatory reclassication as a
liability. This nding not only provides support for the importance of accounting
information in certain contractual settings, but it also contributes to the existing
literature on the effects of mandated accounting changes (for example, El-Gazzar
1993; Frankel et al. 2008).
8
Second, our results are consistent with accounting
classications within the balance sheet affecting rms real capital structure
decisions.
9
In addition to nding our primary debt covenant results within the
context of a mandated classication change, we nd that rms that used the original
TPS proceeds to reclassify then existing debt to mezzanine nancing were more
likely to redeem their TPS. These ndings suggest that accounting classications
within the balance sheet matter and provide support for the importance of current
standard setting debates regarding the denition of a liability (FASB 2007).
The remainder of the paper proceeds as follows. Section 2 discusses TPS securities
as the setting for our study. Section 3 develops hypotheses of rms redeem versus
reclassify choice. Section 4 presents our sample and data. Section 5 presents our
empirical model. Section 6 presents the results and Sect. 7 concludes the paper.
2 Trust preferred stock securities
2.1 Background and prior research
The rst TPS securities (termed MIPS) were introduced by Goldman Sachs & Co. in
1993. The new security exploited differences in book-tax consolidation rules for
special purpose entities to provide a desirable combination of nancial and tax
reporting.
10
Although the securities are treated as debt liabilities generating interest
deductions on the tax return, GAAP rules that were in effect prior to FAS 150 did
not require liability recognition on the balance sheet.
11
Instead, the securities were
8
El-Gazzar (1993) examines the effects of retroactive capitalization of leases under SFAS13 and nds
that reductions in market returns are positively correlated with increased tightness of debt covenants.
Frankel et al. (2008) similarly nd greater usage of tangible net worth covenants (vs. net worth covenants)
after the passage of SFAS 141 and 142 increased the likelihood of net worth covenant violations.
9
This nding complements prior evidence that changes in the short-term versus long-term classication
of debt on the balance sheet have implications for managing leverage ratios (Gramlich et al. 2001) and for
debt-rating downgrades (Gramlich et al. 2006).
10
A discussion of these consolidation rule differences is provided in Mills and Newberry (2005). In a
typical arrangement, the company creates a trust that issues nonvoting preferred stock and transfers the
proceeds to the parent company as a loan. Because the special purpose trust is included in the
consolidated nancial statements, the inter-company loan is eliminated and the preferred stock is reported
on the balance sheet as mezzanine nancing.
11
We do not expect rms tax positions to signicantly affect their redemption choices because the
corporate tax treatment of trust preferred stock as debt remains the same. We conrm this in sensitivity
tests that indicate rms tax rates and excess foreign tax credit positions are not associated with their
redemption choices.
Bank debt covenants and rms responses to FAS 150 liability recognition 359
1 3
classied as mezzanine nancing in a section between liabilities and equity. With
this favorable reporting result, the popularity of TPS grew dramatically throughout
the 1990s and early 2000s, such that estimates of total outstanding offerings totaled
$180 billion by 2002 (McKinnon and Hitt 2002). Reports that Enron relied heavily
on these securities as a source of nancing brought increased regulatory scrutiny
and calls for more transparent nancial reporting (McKinnon and Hitt 2002; Joint
Committee on Taxation 2003).
Early studies of TPS generally focus on the initial years of TPS existence and
rms choices regarding the use of TPS proceeds. Engel et al. (1999) examine the
cost/benet tradeoff for rms that use TPS proceeds to either retire debt or
traditional preferred stock. Specically, they estimate the costs incurred by 44 rms
from 1993 through 1996 that retire debt with the proceeds of TPS issues and
conclude that, on average, the rms in their sample paid $3.9 million in
underwriting fees to reduce their debt ratios by 12.8%. They also examine 28
rms that use TPS proceeds to retire traditional preferred stock and nd that the
present value of the net tax savings averages 28% of the issue size.
Studies that explore the stock market valuation effects of TPS nd mixed results.
Hopkins (1996) nds that balance sheet classication affects the stock price
judgments of buy-side nancial analysts, while Krishnan and Laux (2005) nd that
the market misprices the announcement of new TPS issues if there are no focal
benets. Irvine and Rosenfeld (2000) focus on the use of TPS proceeds and stock
market reactions. They document positive abnormal returns surrounding TPS
announcements when rms use TPS proceeds to retire traditional preferred stock but
nd no signicant valuation effects surrounding TPS announcements when rms
use TPS proceeds to retire debt.
Taken together, these studies suggest that rms received substantive benets
from TPS prior to FAS 150 and that TPS issuances potentially affected the
perceptions of capital market participants. We build on this evidence by
investigating the relation between rms decisions to redeem their TPS after FAS
150 and the terms of their debt contracts.
2.2 Liability recognition under FAS 150
Concerns that rms were not reporting their debt obligations in a sufciently
transparent manner led to the issuance of FAS 150 in May 2003. This new standard
signicantly changed the treatment of TPS because rms were required to reclassify
their outstanding TPS shares as debt liabilities (generally as of the rst interim
period beginning after June 15, 2003).
12
Levi and Segal (2005) examine the
characteristics of rms issuing TPS around the enactment of FAS 150. They nd
that prior to FAS 150, a rms decision to issue TPS is positively related to its debt
12
Although most rms in our sample cite FAS 150 as the underlying reason for reclassifying their
outstanding TPS to the liability section of the balance sheet, some rms cite FASB Interpretation No. 46
(revised December 2003 as FIN46R) requirements to consolidate variable interest entities as the basis for
their reclassications.
360 W. Moser et al.
1 3
level. However, after FAS 150, the relation between TPS issuance and pre-existing
debt levels no longer exists.
13
Similarly, a concurrent study by Hanlon (working
paper, Monash University, 2009) uses a Compustat data item to identify a sample of
mandatorily redeemable preferred stock and links changes in outstanding balances
to nancial covenant characteristics. In an international context, MacKenzie (2006)
and Carlin et al. (2006) nd a period of reduced new issuances for these hybrid
securities following changes in the Australian tax rules.
We use the passage of FAS 150 as a natural setting to test the effects of a
mandated accounting change on rms TPS redemption decisions. Our study links
this decision to lenders reliance on GAAP classications and to rms incentives
surrounding the original issuance. In this way, our study complements, but does not
overlap with, the study by Levi and Segal (2005).
3 Hypotheses development
3.1 Bank debt covenants
Financial covenants reduce the agency costs of debt by providing warning signals of
declining performance. These covenants establish benchmarks for the rm that, if
violated, cause technical default and potential renegotiation of the contract terms.
McCarthy et al. (2004) and Rapoport and Weil (2003) provide examples of
companies that are adversely affected by FAS 150 due to the nature of their
nancial covenants. That is, their lending agreements contain nancial covenants
that rely on debt or interest expense in their construction, and these terms are
dened in accordance with current or oating GAAP. Although bank contracts
can be tailored to the needs of the lending bank and the company, oating GAAP
is frequently relied upon as a method that does not require adjustments to reported
GAAP numbers.
14
With oating GAAP, the denition of debt follows current
balance sheet classications such that TPS is not considered debt prior to FAS 150
but is considered debt after the implementation of FAS 150. We expect these rms
to have greater incentives to redeem their outstanding shares of TPS rather than
reclassify the securities as debt liabilities. We test our prediction with the following
hypothesis:
H1 Firms with bank debt covenants that are adversely affected by FAS 150 are
more likely to redeem their TPS after the passage of FAS 150.
13
Levi and Segal (2005) nd evidence of rms continuing to issue TPS in the post-FAS 150 period,
while we nd only one rm in our sample of industrial rms issuing TPS after FAS 150. This difference is
likely due to the exclusion of regulated rms (nancials and utilities) from our sample.
14
Prior research explores instances in which lenders make adjustments to GAAP accounting. For
example, Beatty et al. (2008) nd an association between income escalators in net worth covenants and
accounting conservatism, while Li (2009) nds evidence of adjustments for transitory components in
contractual denitions of earnings and net assets.
Bank debt covenants and rms responses to FAS 150 liability recognition 361
1 3
3.2 Original use of trust preferred stock proceeds
Much of the prior research on TPS focuses on the extent to which rms took
advantage of enhanced balance sheet reporting versus the tax deductibility feature of
the security. If a rm wanted to maximize its balance sheet reporting, the proceeds
from the original TPS issuance could be used to retire existing debt. By using the
proceeds to retire existing debt, a rm could reclassify its debt liabilities to the
mezzanine section of the balance sheet (between liabilities and equity). At the other
extreme, if the rm wanted to take full advantage of the securitys attractive tax
features, the original TPS issue proceeds could be used to retire traditional preferred
stock or common stock (both with nondeductible dividend payments). This usage
would not enhance the balance sheet because the TPS would merely replace an
existing form of equity. Between these two extremes, rms could use the proceeds
as a substitute for issuing additional debt or equity by using the proceeds to fund
ongoing general corporate needs. We test the prediction that rms that used the
original proceeds of their TPS issuances for balance sheet enhancement are more
likely to redeem (versus reclassify) the securities with the following hypothesis:
H2 Firms that used the original issuance proceeds to retire existing debt are more
likely to redeem their TPS after the passage of FAS 150.
4 Sample and data
Our sample consists of industrial rms with outstanding TPS in 2002 (the year prior
to the enactment of FAS 150). To identify the sample, we use DirectEdgar to search
all 10-K lings between 1993 and 2005 using search terms associated with TPS
issuances. We use a comprehensive set of search terms with the most common
examples including: mandatorily redeemable, trust preferred, subsidiary trust
company-obligated, subsidiary trust, subsidiary capital trust, and subordinated
debentures. Appendix A provides examples of the TPS disclosures identied
using these search methods.
We eliminate nancial rms (SIC 6000-6900) and public utilities (SIC
4900-4999) from our test sample because the regulatory incentives of these rms
could confound the FAS 150 incentive results.
15
Our initial sample contains 78
industrial rms with outstanding TPS between 1993 and 2005. Because our focus is
on rms incentives to reclassify or redeem TPS around the enactment of FAS 150,
we eliminate 14 rms that redeemed all of their outstanding TPS prior to 2002. We
match the remaining 64 sample rms to the merged Compustat annual industrial le
to obtain information on market value of equity, market-to-book ratios, pretax
income, long-term debt, assets, external capital, and bond ratings. We eliminate six
rms with no Compustat information, yielding a nal sample of 58 rms.
For each of the 58 rms, we collect information on the rms stated use of the
original TPS proceeds, the issue amount, and redemption provisions. Following the
15
For example, the Federal Reserve ruled that TPS qualied as Tier 1 equity capital for banks in 1996,
and insurance companies are subject to capital adequacy requirements.
362 W. Moser et al.
1 3
methodology of Engel et al. (1999) and Irvine and Rosenfeld (2000), we collect this
information from the offering prospectus and 10-K footnotes.
The Securities and Exchange Commission (SEC) requires that rms disclose
material debt covenant agreements. We review the exhibits to the annual 10-K
lings because these covenants are typically reported in Exhibit 4 or Exhibit 10. In
addition, we search the SEC website using a variety of search terms including
nancial covenant, debt covenant, amended agreement, and credit agreement. Our
search yields bank debt covenant data for 54 of our 58 sample rms. For the
remaining four rms, we assume that there are no material debt covenant
agreements. In untabulated robustness tests, we also eliminate these four rms from
our empirical analysis and nd results resembling those reported.
We read each of the bank debt covenants to determine the nature of the covenants
(for example, net worth, quick ratio, debt ratio, or interest coverage ratio). For those
rms with nancial covenants using debt or interest in their calculation (for
example, covenants potentially affected by liability recognition), we evaluate the
covenant denitions. In particular, we are interested in whether the denition of debt
or interest expense uses oating GAAP or xed GAAP, explicitly includes
TPS, or explicitly excludes TPS.
16
5 Empirical model
We examine whether mandated TPS liability recognition under FAS 150 inuenced
rms redemption versus reclassication choice using the following general model:
Redeem f Affected Covenant; OI Retire Debt; Control Variables 1
Our multivariate analysis uses a logistic regression to estimate three alternative
models. Model 1 uses Affected Covenants as the test variable (consistent with
hypothesis 1), model 2 uses OI-Retire Debt as the test variable (consistent with
hypothesis 2), and model 3 includes both test variables. Model 3 allows for a test of
incremental effects.
5.1 Dependent variable
Redeem is a binomial variable that equals 1 if a rm redeems a majority of its TPS
in the period following the enactment of FAS 150 (2003 through 2005) and 0 if the
rm chooses to reclassify its outstanding TPS as a liability. We verify rms choices
by examining their 10-K lings in the years following the enactment of FAS 150.
Our review of rms lings after FAS 150 reveals that, of all the rms that did not
redeem their shares, only one made an argument for not reclassifying its TPS as a
liability.
17
We also consider whether the terms of the TPS precluded redemption
16
See Appendix B for examples of debt covenant agreements that either explicitly exclude or include
TPS in the denition of debt in the covenant agreement.
17
Kimberly-Clark issued TPS from its Luxembourg-based nancing subsidiary. In turn, the Luxem-
bourg-based nancing subsidiary loaned 97% of the proceeds from the issuance to Kimberly-Clark at a
xed rate of interest. In its annual report for 2004, Kimberly-Clark Corporation maintained that the
Bank debt covenants and rms responses to FAS 150 liability recognition 363
1 3
during our post-FAS 150 test period. Based on our review of subsequent lings, we
conclude that all sample rms had the ability to redeem their TPS during the period
from 2003 through 2005.
5.2 Test variables
We construct the variable Affected Covenants based on our evaluation of rms
bank lending agreements and denitions of nancial covenant terms relying on debt
or interest in their measurement. We code Affected Covenants as 1 for those rms
with bank debt covenants that would be affected by liability recognition based on
the terms of the contract and 0 otherwise. For example, if the denition of covenant
terms allows oating GAAP to dene debt (which would exclude TPS prior to
FAS 150 and include it after FAS 150), the variable Affected Covenants is coded as
1. If, instead, the denition of the covenant terms is uniform before and after the
enactment of FAS 150 (TPS was explicitly included in debt, TPS was explicitly
excluded from debt, or debt is dened using xed GAAP) the variable Affected
Covenants is coded as 0.
18
If the rms nancial covenants do not specically
include debt or interest in their measurement (for example, current and net worth
ratios), Affected Covenants is also coded as 0. Hypothesis 1 predicts a positive
coefcient on Affected Covenants.
We construct the variable OI-Retire Debt based on the rms stated use of the
proceeds from the original TPS issuance. We classify each use of the proceeds into
one of three categories. OI-Retire Debt indicates that the proceeds from issuing TPS
were used primarily to retire existing debt. OI-Stock indicates that the proceeds were
used primarily to retire traditional preferred stock or common stock. Finally, OI-
General Purpose indicates that the proceeds were used primarily for general
corporate purposes. Our test of OI-Retire Debt captures the likelihood of rms
choosing to redeem their outstanding TPS after FAS 150 if the original proceeds
were used to retire existing debt versus for other purposes. Hypothesis 2 predicts a
positive coefcient on OI-Retire Debt.
5.3 Control variables
We also include the following rm-specic control variables: LnMVE, Market-to-
Book, ROA, Debt Ratio, TPS/External Capital, and Non-Investment Grade. These
variables are all calculated as of the beginning of the 2003 scal year. LnMVE,
measured as the natural log of market equity, provides a general control for rm
size. Market-to-Book, measured as market value of equity to book value of equity,
Footnote 17 continued
foreign nancing subsidiary with its xed interest obligation should not be consolidated in its nancial
statements. As a result, Kimberly-Clark continued to report its TPS in the mezzanine section of its
balance sheet.
18
We nd two instances where rms negotiated with lenders in response to FAS 150. For example, Dura
Automotive negotiated a 2003 amendment to its debt covenant agreement that specically excluded TPS
from the denition of debt. Any measurement error resulting from our failure to nd other renegotiated
covenant agreements should bias against nding results consistent with our hypotheses.
364 W. Moser et al.
1 3
controls for the rms growth opportunities. ROA, measured as pretax income to
total assets, controls for protability. These variables serve as general controls for
which we make no sign predictions.
Debt Ratio, measured as long-term debt to total assets, controls for leverage. We
expect a negative coefcient on Debt Ratio if rms with higher leverage, on
average, have fewer opportunities to renance their TPS.
TPS/External Capital, measured as the outstanding balance of TPS to total
external capital, controls for the materiality of the rms TPS holdings. Firms that
rely more heavily on TPS as an external funding source are likely more sensitive to
reclassifying the securities as a debt liability. Thus, we predict a positive coefcient
on TPS/External Capital.
Finally, Non-Investment Grade, a dummy variable coded as 1 for rms with a
Standard & Poors debt rating below BBB- (or no rating), controls for the rms
creditworthiness. Firms with bond ratings below investment grade may have fewer
(or costlier) opportunities to raise capital to redeem their outstanding TPS. Thus, we
expect a negative coefcient on Non-Investment Grade.
6 Results
6.1 Summary statistics
As shown in Fig. 1, our sample rms increasingly used TPS nancing over the
period 1993 through 2002, with the outstanding balance approaching $25 billion by
2002. However, by 2005 the outstanding amount is reduced by almost 60% (to
approximately $10 billion). This dramatic decline following the enactment of FAS
150 suggests that the new mandate requiring TPS to be recognized as a liability
created an environment where rms were motivated to make substantive changes to
their capital structure.
We present descriptive statistics for our sample of industrial rms in Panel A of
Table 1. Out of 58 sample rms, 22 have debt covenants that are adversely affected
by FAS 150 (Affected Covenant = 1).
19
Firms in our sample have, on average, a
market value of equity (MVE) of $4.3 billion, Market-to-Book ratios of 2.978, and
negative returns on assets (ROA) of -1.8%. In addition, our rms have an average
Debt Ratio (long term debt divided by external capital) of 0.366 and approximately
47% have public debt rated as non-investment grade by Standard & Poors. These
statistics suggest that, although our sample rms are large, they tend to have low
protability and do not have cost-effective access to public debt markets.
We also present summary statistics by the rms use of the original TPS proceeds
in Panel B of Table 1. Out of 58 sample rms, 27 used TPS proceeds to retire debt,
three used TPS proceeds to retire stock, and 28 used TPS proceeds for general
19
Of the 36 rms that do not have Affected Covenants, 17 rms have debt covenant agreements that
specically included or specically excluded TPS from the denition of debt or interest, 15 rms have
debt covenant agreements that do not rely on debt on interest in their measurement (e.g., cash balances,
net worth, or dividend restrictions), and the remaining four rms are not subject to nancial debt
covenants.
Bank debt covenants and rms responses to FAS 150 liability recognition 365
1 3
Table 1 Summary statistics
Variable N Mean Std Dev Lower quartile Median Upper quartile
Panel A: full sample
Affected covenants 58 0.379 0.489 0.000 0.000 1.000
OI-retire debt 58 0.466 0.503 0.000 0.000 1.000
MVE 58 4,323.2 6,919.6 379.7 1,270.6 3,957.6
Market-to-book 58 2.978 3.163 0.633 2.050 3.549
ROA 58 -0.018 0.134 -0.047 0.010 0.053
Debt ratio 58 0.366 0.176 0.272 0.346 0.435
TPS/external capital 58 0.189 0.290 0.056 0.100 0.205
Non-investment grade 58 0.466 0.503 0.000 0.000 1.000
Panel B: by use of original issue (OI) proceeds
OI-retire debt
Affected covenants 27 0.556 0.506 0.000 1.000 1.000
MVE 27 5,810.4 8,263.0 439.3 1,864.9 10,750.1
Market-to-book 27 2.933 2.814 1.110 2.182 3.549
ROA 27 -0.003 0.064 -0.047 0.003 0.046
Debt ratio 27 0.414 0.187 0.272 0.369 0.506
TPS/external capital 27 0.220 0.383 0.056 0.088 0.166
Non-investment grade 27 0.444 0.506 0.000 0.000 1.000
OI-retire stock
Affected covenants 3 0.333 0.577 0.000 0.000 1.000
MVE 3 2,932.1 4,294.2 347.1 560.1 7,889.0
Market-to-book 3 7.077 2.837 5.196 5.695 10.339
ROA 3 0.043 0.044 -0.007 0.057 0.077
Debt ratio 3 0.269 0.132 0.118 0.328 0.362
TPS/external capital 3 0.182 0.089 0.122 0.140 0.285
Non-investment grade 3 0.333 0.577 0.000 0.000 1.000
OI-general purposes
Affected covenants 28 0.404 0.492 0.000 0.000 1.000
MVE 28 3,038.1 5,461.4 334.8 961.0 3,042.5
Market-to-book 28 2.582 3.297 0.455 1.502 2.778
ROA 28 -0.040 0.181 -0.059 0.012 0.059
Debt ratio 28 0.329 0.159 0.274 0.334 0.409
TPS/external capital 28 0.159 0.184 0.041 0.124 0.209
Non-investment grade 28 0.500 0.509 0.000 0.500 1.000
This table reports summary statistics for our sample of 58 industrial rms with outstanding trust preferred stock prior to
the enactment of FAS 150. Affected Covenants is a dummy variable coded as 1 if a rm has bank debt covenants that are
affected by the FAS 150 liability recognition and 0 otherwise. OI-Retire Debt is a dummy variable coded as 1 if a rm
used the proceeds of the original trust preferred stock issue to retire existing debt and 0 otherwise. MVE is the market
value of equity (Data25 * Data199). Market-to-Book is market value of equity (Data25 * Data199) divided by common
equity (Data60). ROA is the prior year pretax income (Data 170) divided by total assets (Data6). Debt Ratio is long-term
debt (Data9) divided by total assets (Data6). TPS/External Capital is outstanding trust preferred stock divided by
external capital, where External Capital is long-term debt (Data9) plus short-term debt (Data34) ? preferred stock
(Data130) ? common equity (Data60) - retained earnings (Data36). Non-Investment Grade is a dummy variable coded
as 1 if the rm had an S&P Debt rating below BBB- (or no rating) and 0 otherwise. Panel A presents results for the full
sample of trust preferred stock. Panel B reports summary statistics for three subsamples of trust preferred stock classied
according to the rms use of the original issue proceeds
366 W. Moser et al.
1 3
corporate purposes. On average, we nd that those rms using TPS proceeds to
retire debt are larger ($5.8 billion) than rms using the proceeds to retire stock ($2.9
billion) or for general purposes ($3.03 billion). We also nd evidence of larger Debt
Ratios and Affected Covenants in the retire debt subsample.
6.2 Univariate analyses
We conduct univariate tests of differences for the characteristics of rms that chose
to redeem their TPS versus those that chose to reclassify their TPS as a debt
liability. These results are reported in Table 2. Our tests of differences in means
show that rms redeeming (versus reclassifying) their TPS are more likely to have
Affected Covenants, IO-Retire Debt, and higher TPS/external capital. Fifty percent
of redeeming rms have bank debt covenants that are adversely affected by FAS
150, compared with 18.2% of reclassifying rms. This is consistent with our
hypothesis 1 prediction. We also nd that 55.6% of rms in the redeeming sample
used the original TPS proceeds to retire existing debt versus 31.8% of rms in the
reclassify sample. Thus, the univariate results are also consistent with hypothesis 2.
We present a Pearson correlation matrix in Table 3. The correlation matrix shows
that our test variables, Affected Covenants and OI-Retire Debt, are positively
correlated (q = 0.298, p value = 0.023). We estimate our test variables both
separately and together in our regression specication to allow for tests of
incremental effects and to calculate separate elasticities for each variable while
holding other independent variables at their mean levels. Our control variables also
have some expected correlation. In particular, larger rms (LnMVE) have higher
return on assets (ROA), less reliance on TPS as a percentage of external funding
Table 2 Univariate tests
Redeem Reclassify Diff. in means T statistic
N Mean N Mean
Affected covenants 36 0.500 22 0.182 0.318*** 2.670
OI-retire debt 36 0.556 22 0.318 0.237* 1.800
MVE 36 4,063.5 22 4,748.1 -684.7 -0.330
Market-to-book 36 3.212 22 2.594 0.618 0.740
ROA 36 -0.035 22 0.009 -0.044 -1.470
Debt ratio 36 0.362 22 0.372 -0.010 -0.200
TPS/external capital 36 0.235 22 0.114 0.121* 1.930
Non-investment grade 36 0.472 22 0.455 -0.005 0.133
The table presents univariate results for tests of differences in the characteristics of rms that redeemed
their trust preferred stock (Redeem) in the 2003 through 2005 period following the enactment of FAS 150
and rms that did not redeem their trust preferred stock (Reclassify). Affected Covenants, OI-Retire Debt,
MVE, Market-to-Book, ROA, Debt Ratio, TPS/External Capital, and Non-Investment Grade are dened in
Table 1
***, **, and * denotes signicance at the 1, 5, and 10% level, respectively
Bank debt covenants and rms responses to FAS 150 liability recognition 367
1 3
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368 W. Moser et al.
1 3
sources (TPS/External Capital), and greater access to investment-grade public debt
(Non-Investment Grade).
6.3 Multivariate analyses
We report three specications of our logistic regression in Table 4. Models 1 and 2
include Affected Covenants and OI-Retire Debt as separate terms, respectively. In
Model 3, we include both terms to test for incremental effects. Model 1 has a pseudo
R
2
of 19.10% and a correct prediction rate of 78.3%, while model 2 has a pseudo R
2
of 12.90% and a correct prediction rate of 73.7%. The greater explanatory power of
model 1 suggests that Affected Covenants is a stronger predictor of rms redeem
versus reclassify choices. Model 3, which includes both Affected Covenants and
OI-Retire Debt, has the highest explanatory power with a pseudo R
2
of 23.0% and a
correct prediction rate of 80.8%.
When included separately, the coefcients on Affected Covenants (1.949,
t-statistic = 2.61) and OI-Retire Debt (1.299, t statistic = 1.85) are positive and
Table 4 Logistic regressions
Model 1 Model 2 Model 3
Variables
Intercept -4.178* (1.89) -3.777* (1.66) -4.228* (1.89)
Affected covenants 1.949*** (2.61) 1.774** (2.29)
OI-retire debt 1.299* (1.85) 0.967 (1.26)
LnMVE 0.482* (1.67) 0.434* (1.68) 0.484* (1.66)
Market-to-book 0.116 (0.97) 0.103 (0.83) 0.128 (1.05)
ROA -9.599* (1.94) -8.071* (1.82) -9.514* (1.92)
Debt ratio -0.595 (0.25) -2.121 (1.03) -1.296 (0.54)
TPS/external capital 7.148* (1.69) 4.745 (1.53) 6.398 (1.60)
Non-investment grade 0.904 (1.08) 1.041 (1.35) 1.141 (0.19)
Observations 58 58 58
Pseudo R
2
19.10% 12.90% 23.00%
Correction prediction (%) 78.30% 73.70% 80.80%
Elasticity estimate 26.88% 22.35% n.a.
This table presents logistic regressions for the determinants of the choice to redeem (versus reclassify)
trust preferred stock after FAS 150. The sample consists of 58 industrial rms, 36 of which chose to
redeem. The dependent variable, Redeem, is a binomial variable coded 1 if the rm chose to redeem its
trust preferred stock in the 2003 through 2005 period following the enactment of FAS 150 and 0
otherwise. Affected Covenants, OI-Retire Debt, MVE, Market-to-Book, ROA, Debt Ratio, TPS/External
Capital, and Non-Investment Grade are dened in Table 1. Elasticity Estimates for Affected Covenants
(in model 1) are computed as the difference in probability of having Affected Covenants, estimated using
models with Affected Covenants = 0 versus Affected Covenants = 1 while holding other variables at the
mean values. Elasticity Estimates for OI-Retire Debt (in model 2) are computed as the difference in
probability of having OI-Retire Debt, estimated using models with OI-Retire Debt = 0 versus OI-Retire
Debt = 1 while holding other variables at the mean values. T statistics are in parentheses below each
coefcient estimate
***, **, and * denotes signicance at the 1, 5, and 10% level, respectively
Bank debt covenants and rms responses to FAS 150 liability recognition 369
1 3
signicant. We estimate the elasticity of each variable and nd that the probability
of redeeming TPS increases by 26.88% for rms with Affected Covenants and by
22.35% for rms that used the original TPS proceeds to retire debt (OI-Retire Debt).
In the combined estimation (model 3), only Affected Covenants is signicant. Our
regression results are consistent with both hypotheses 1 and 2 and with Affected
Covenants providing the dominant effect.
The results for the control variables provide some evidence that the probability of
redeeming TPS declines with protability (ROA) and increases with the magnitude
of TPS as a proportion of external funding sources (TPS/External Capital). After
controlling for these effects, there is also a positive relation between rm size
(LnMVE) and the probability of redeeming TPS.
Overall, our results provide evidence of the importance of balance sheet
classications for rms with binding debt contracts and their willingness to make
substantive capital structure changes in response to the new reporting requirements
of FAS 150.
6.4 Supplemental test variable specication
We supplement our multivariate analysis using a coarser measure of bank debt
covenants: Financial Covenants. Financial Covenants is a binomial variable coded
as 1 for rms with bank debt covenants that include debt or interest in their
calculation and 0 otherwise. In contrast to Affected Covenants, this variable makes
no attempt to distinguish between oating or xed GAAP as the basis for
dening the debt or interest terms. In effect, this alternative specication provides
evidence on the importance of identifying the specic contractual terms in our tests
of a relationship between debt covenants and TPS redemption decisions.
We report our logistic regression analysis using Financial Covenants as the test
variable in Table 5. The coefcient on Financial Covenants (0.809, t statis-
tic = 1.17) is positive but insignicant. Consistent with Beatty et al. (2002) and
Fields et al. (2001), we conclude that actual debt covenants yield more powerful
tests than proxies.
6.5 Method of redemption
To better understand our rms redemption choices and their underlying incentives,
we also report supplemental data on the method of redemption in Table 6.
Specically, we examine the 10-K ling disclosures of the 36 redeeming rms to
conrm the method and dollar value of their redemptions. Based on these
disclosures and corroborating cash ow statement data, we partition the source of
the redemption funds into four categories: issue/convert to common stock, cash ow
from operations, issue new debt, and multiple sources.
The method of redemption is explicitly stated in the footnotes to the nancial
statements for the 18 rms that nanced their TPS redemptions by issuing new
common stock or exercising TPS conversion features. We estimate that these
redemptions (totaling $7.083 billion) resulted in the forfeiture of more than $495
370 W. Moser et al.
1 3
Table 5 Supplemental logistic regression using Financial Covenants
Model 1
Variables
Intercept -4.047* (1.75)
Financial covenants 0.809 (1.17)
LnMVE 0.447* (1.79)
Market-to-book 0.097 (0.81)
ROA -7.978* (1.83)
Debt ratio -1.725 (0.81)
TPS/external capital 5.276 (1.54)
Non-investment grade 0.737 (1.00)
Observations 58
Pseudo R
2
9.55%
Correction prediction (%) 72.60%
This table presents logistic regressions for the determinants of the choice to redeem (versus reclassify)
trust preferred stock after FAS 150. The sample consists of 58 industrial rms, 36 of which chose to
redeem. The dependent variable, Redeem, is a binomial variable coded 1 if the rm chose to redeem its
trust preferred stock in the 2003 through 2005 period following the enactment of FAS 150 versus
reclassifying the TPS as a debt liability and 0 otherwise. Financial Covenants is a dummy variable coded
as 1 if a rm has bank debt covenants that include debt or interest in their terms. In contrast to Affected
Covenants, Financial Covenants makes no attempt to distinguish covenant terms that are actually affected
by FAS 150 due to the use of oating GAAP. MVE, Market-to-Book, ROA, Debt Ratio, TPS/External
Capital, and Non-Investment Grade are dened in Table 1. T statistics are in parentheses below each
coefcient estimate
***, **, and * denotes signicance at the 1, 5, and 10% level, respectively
Table 6 Redemption method
Number $ Million
redemption
Number where
OI-retire debt
$ Million where
OI-retire debt
Issue/convert to common stock 18 7,083 9 5,023
Cash ow from operations 10 5,452 6 3,873
Issue new debt 1 265 0 0
Multiple sources 7 2,002 4 1,414
Total redemptions 36 14,802 19 10,310
The table reports summary statistics on the method of redemption for 36 industrial rms that redeemed
their trust preferred stock following the enactment of FAS 150 during the 2003 through 2005 period. We
partition redemptions into four categories based on the source of funds used to redeem trust preferred
stock. The categories are (1) issue/convert to common stock, (2) cash ow from operations, (3) issue new
debt, and (4) multiple sources. For each category we report the number of TPS redemptions and the
corresponding dollar amount (in millions) of trust preferred stock redeemed. We also report statistics for a
subcategory of redeeming rms that used the proceeds of the original trust preferred stock issue to retire
existing debt (OI-Retire Debt)
Bank debt covenants and rms responses to FAS 150 liability recognition 371
1 3
million in annual interest deductions with a potential tax cost of $173 million.
20
For
the remaining 18 redeeming rms (id est, those that did not redeem using only
common stock), we use data from the cash ow statements to determine available
funding sources. It appears that only one of these rms would be required to issue
new debt to nance its TPS redemption. This is consistent with rms minimizing the
consequences of liability recognition rather than simply replacing a less attractive
security with other sources of lower cost debt.
Our nding that some rms chose to redeem their TPS rather than renegotiate with
lenders suggests that these rms either could not amend their debt contracts or faced
higher relative renegotiation costs. Prior research suggests that the cost of negotiating
exibility in debt contracts can be large. Beatty et al. (2002) nd evidence that rms
pay substantially higher interest rates to retain accounting exibility that may help
them avoid covenant violations. Recent studies in nancial economics (for example,
Roberts and Su2009) further cite amendment fees, the bargaining power of borrowers
to switch lenders, costs incurred in the form of time and effort, and macroeconomic
uctuations in credit and equity markets as signicant factors that affect renegotiation
costs.
21
Overall, our results suggest that rms adversely affected by FAS 150 liability
recognition incurred signicant costs to mitigate the effects on their debt contracts.
7 Conclusions
The passage of FAS 150 in 2003 provides a natural experiment to investigate the
relation between debt contracting and nancial reporting choices. FAS 150
mandated that certain securities (for example, trust preferred stock) be reclassied
from mezzanine nancing to debt liabilities. Although rms have economic
incentives to avoid covenant violations (Watts and Zimmerman 1986, 1990),
empirical evidence is largely inconclusive on the relation between nancial
covenants and accounting choice. We contribute to this literature by examining the
relation between nancial covenant restrictions and rms choice to redeem or
reclassify their outstanding TPS following the enactment of FAS 150.
Our ndings suggest that bank debt covenants signicantly affect rms
economic responses to a mandated accounting change. For rms with bank debt
covenants that are adversely affected by the mandatory accounting change, we nd
a 26.88% increase in the probability that the rm will redeem its TPS. We also
provide evidence that a rms original use of TPS proceeds affects its redemption
decisions in the post-FAS 150 period. Specically, rms that issued TPS to retire
outstanding debt are 22.35% more likely to redeem their outstanding TPS.
20
This calculation is in the spirit of Engel et al. (1999) who use estimated tax savings as a gauge of the
benets from issuing TPS to retire traditional preferred stock. Similar to Engel et al. (1999), we use 35%
as the marginal tax rate for this purpose.
21
Roberts and Su (2009) nd that renegotiations are highly pro-cyclical and that the terms of the
renegotiation are signicantly more favorable for the borrower during periods of economic expansion.
This nding is particularly relevant for rms in our sample since bank loan renegotiations would have
occurred during or immediately following the 2001 recession (the end of the 2001 recession was not
determined by the National Bureau of Economic Research until July 17, 2003).
372 W. Moser et al.
1 3
Our study makes several contributions to the existing literature. First, our
ndings suggest that when bank debt contracts rely on oating GAAP in their
construction of nancial covenants, changes in the underlying GAAP measures can
signicantly inuence rms economic behavior. Second, our results are consistent
with accounting classications within the balance sheet affecting rms real capital
structure decisions. Finally, we provide support for the importance of current
standard setting debates regarding the denition of a liability.
Acknowledgments We would like to thank Richard Sloan (the editor), two anonymous referees, and
seminar participants at the University of Missouri, Texas A&M, and the 2007 American Accounting
Association annual meeting. This paper was presented at the 2007 American Accounting Association
annual meeting with the title Debt Covenants, Balance Sheet Classication, and the Effects of FAS 150:
Evidence from Trust Preferred Stock.
Appendix A: Financial statement disclosures of trust preferred stock holdings
Textron, Inc.
Note 11. TextronObligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trust Holding Solely Textron Junior Subordinated Debt Securities.
In 1996, a trust sponsored and wholly owned by Textron issued preferred securities
to the public (for $500 million) and shares of its common securities to Textron (for
$15.5 million), the proceeds of which were invested by the trust in $515.5 million
aggregate principal amount of Textrons newly issued 7.92% Junior Subordinated
Deferrable Interest Debentures, due 2045. The debentures are the sole asset of the
trust. The proceeds from the issuance of the debentures were used by Textron for the
repayment of long term borrowings and for general corporate purposes. The amounts
due to the trust under the debentures and the related income statement amounts have
been eliminated in Textrons consolidated nancial statements.
The preferred securities accrue and pay cash distributions quarterly at a rate of
7.92% per annum. Textron has guaranteed, on a subordinated basis, distributions
and other payments due on the preferred securities. The guarantee, when taken
together with Textrons obligations under the debentures and in the indenture
pursuant to which the debentures were issued and Textrons obligations under the
Amended and Restated Declaration of Trust governing the trust, provides a full and
unconditional guarantee of amounts due on the preferred securities. The preferred
securities are mandatorily redeemable upon the maturity of the debentures on March
31, 2045, or earlier to the extent of any redemption by Textron of any debentures.
The redemption price in either such case will be $25 per share plus accrued and
unpaid distributions to the date xed for redemption.
Dillards
6. Guaranteed Preferred Benecial Interests in the Companys Subordinated
Debentures
Bank debt covenants and rms responses to FAS 150 liability recognition 373
1 3
Guaranteed Preferred Benecial Interests in the Companys Subordinated
Debentures are comprised of $200 million liquidation amount of 7.5% Capital
Securities, due August 1, 2038 (the Capital Securities) representing benecial
ownership interest in the assets of Dillards Capital Trust I, a wholly owned
subsidiary of the Company, and $331.6 million liquidation amount of LIBOR plus
1.56% Preferred Securities, due January 29, 2009 (the Preferred Securities) by
Horatio Finance V.O.F, a wholly owned subsidiary of the Company.
Holders of the Capital Securities are entitled to receive cumulative cash
distributions, payable quarterly, at the annual rate of 7.5% of the liquidation amount
of $25 per Capital Security. The subordinated debentures are the sole assets of the
Trust and the Capital Securities are subject to mandatory redemption upon
repayment of the subordinated debentures. Holders of the Preferred Securities are
entitled to receive quarterly dividends at LIBOR plus 1.56%. The Preferred
Securities are subject to mandatory redemption upon repayment of the debentures.
The Companys obligations under the debentures and related agreements, taken
together, provide a full and unconditional guarantee of payments due on the Capital
and Preferred Securities.
Appendix B: Debt covenant denitions in bank lending agreements
United Rentals Inc
Specically Excludes Trust Preferred Stock (QUIPS)
Funded Debt means (a) all Debt of Holdings and its Subsidiaries and (b) to the
extent not included in the denition of Debt, without duplication, all Outstanding
Securitization Obligations, but excluding (1) contingent obligations in respect of
undrawn letters of credit and Suretyship Liabilities (except to the extent constituting
contingent obligations or Suretyship Liabilities in respect of Funded Debt of a
Person other than Holdings or any Subsidiary), (2) Hedging Obligations, (3) Debt of
Holdings to Subsidiaries and Debt of Subsidiaries to Holdings or to other
Subsidiaries and (4) Debt (including guaranties thereof) in respect of the QuIPS
Debentures and the QuIPS Preferred Securities. It is understood that the Tranche B
Credit-Linked Deposits shall not constitute Funded Debt.
Central Parking Corporation
Specically Includes Trust Preferred Stock in Debt
Funded Debt means, with respect to any Person, without duplication, (1) all
Indebtedness of such Person for borrowed money, (2) all purchase Money
Indebtedness of such Person, including without limitation the principal portion of all
obligations of such Person under Capital Leases, (3) all Guaranty Obligations of
such Person with respect to Funded Debt of another Person, (4) the maximum
available amount of all standby letters of credit or acceptances issued or created for
374 W. Moser et al.
1 3
them account of such Person, (5) all Funded Debt of no other Person secured by a
Lien on any Property of such Person, whether or not such Funded Debt has been
assumed, provided that for purposes hereof the amount of such Funded Debt shall be
limited to the greater of (A) the amount of such Funded Debt as to which there is
recourse to such Person and (B) the fair market value of the property which is
subject to the Lien, (6) the principal Balance outstanding under any Synthetic Lease,
and (7) the principal amount of the subordinated notes issued by the Parent to the PS
Subsidiary in connection with the Preferred Stock. The Funded Debt of any Person
shall include the funded Debt of any partnership or joint venture in which such
Person is a general partner or joint venture.
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