The Information Content of Calls of Convertible Preferreds: The Evidence from Earnings Forecasts

Abstract

This paper examines the impact of the announcement of convertible preferred calls on earnings forecasts by financial analysts. Our results show that in-the-money calls are associated with no change in either forecasted earnings or forecasted long-term earnings growth. In addition, we find that the abnormal return around the announcement of the call is uncorrelated with changes in earnings or long-term growth rates, Similar results are obtained from the analysis of earnings changes around out-of-themoney calls. Out-of-the-money calls, however, are associated with marginally significant increases in forecasts of long-term growth, but these increases are not correlated with the announcement period abnormal returns. These results suggest that any information inherent in convertible preferred calls is not associated with future earnings. Therefore, they are more consistent with the Jensen free-cash-$ow hypothesis than the Harris-Raviv signaling hypothesis.

The Information Content of Commercial Paper Rating Downgrades: Further Evidence

“…They do not find any significant revisions in earnings forecasts, even though such announcements are associated with a negative stock price reaction. Given their evidence, Shastri and Shastri (1995) conclude that announcements of calls of convertible preferred stock do not convey information about future cash flows. In a similar vein, we attempt to determine whether CP rating downgrades convey information about future cash flows of the affected firms by examining changes in earnings expectations and equity betas.…”

“…Bartov (1991) examined the market reaction to open market share repurchase announcements, and found that they are associated with upward revisions in analyst earnings forecasts and declines in equity betas for the repurchasing firms. More recently, Shastri and Shastri (1995) examined earnings forecast revisions and risk changes associated with announcements of calls of convertible preferred stocks. They do not find any significant revisions in earnings forecasts, even though such announcements are associated with a negative stock price reaction.…”

The Importance of Call Delays and Cash Flow Positions in Evaluating the Information Content of Convertible Preferred Stock Calls

“…They find that analysts' forecasts are not revised significantly, but that the variance of analysts' forecasts decreases after calls are announced. Shastri and Shastri (1996) also document a significant increase in earnings per share during the call year. These results, as well as Asquith's (1995) finding of little or no delay for calls of convertible bonds, run counter to signaling models that treat calls as being indicative of decreased expected future cash flows.…”

“…The purpose of these studies (e.g., Byrd and Moore [1996]; Shastri and Shastri [1996]; Campbell, Ederington, and Vankudre [1991]) is to determine whether calls convey information to the market. Although such studies typically conclude that no material earnings-based signals are sent, at least one critical oversight persists-tests for information effects invariably are conducted without properly accounting for whether the underlying calls are delayed.…”

Rational Timing of Calls of Convertible Preferred Stocks

“…Negative call announcement effects are documented for convertible bonds (Mikkelson (1981» as well as for convertible preferred stocks (Mais, Moore, and Rogers (1989». However, these findings are challenged by evidence that the negative effects are short lived (Mazzeo andMoore (1992». Furthermore, Ofer andNatarajan (1987) report evidence ofpost-call earnings deterioration and negative stock performance, although their finding is challenged by Campbell, Ederington, and Vankudre (1991) (see also Cowan, Nayar, and Singh (1990) and Singh, Cowan, and Nayar (1991». More recently, Byrd and Moore (1996) and Shastri and Shastri (1995) find that earnings forecast revisions following conversion-forcing calls are inconsistent with the notion that such calls portend poor earnings.…”