bank debt covenants and firms’ responses to fas 150 liability recognition. evidence from trust...

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Bank debt covenants and firms responses to FAS 150

liability recognition: evidence from trust preferredstock

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 firms with trust preferred stock (TPS) to mandated lia-

bility recognition under Financial Accounting Standard (FAS) 150. Our results

show that firms financial covenants significantly affect their choice to redeem

versus reclassify their outstanding TPS. Specifically, firms 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 find that firms are sig-nificantly 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 findings suggest that when bank debt contracts use floating

Generally Accepted Accounting Principles (GAAP) to construct financial covenant

terms, changes in the underlying GAAP measure significantly influence firms

economic behavior.

Keywords Bank debt Debt covenants Trust preferred stock FAS 150

JEL Classifications G21 G32 K12 M40

W. Moser (&)Trulaske College of Business, University of Missouri, 432 Cornell Hall, Columbia, MO 65211, USAe-mail: [email protected]

K. NewberryC.T. Bauer College of Business, University of Houston, 360D Melcher Hall, Houston,

TX 77204, USAe-mail: [email protected]

A. PuckettCollege of Business, 437 Stokely Management Center, University of Tennessee, Knoxville,TN 37996, USA

e-mail: [email protected]

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Rev Account Stud (2011) 16:355376DOI 10.1007/s11142-011-9143-x


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1 Introduction

We examine the association between financial debt covenants and the economic

responses of firms with trust preferred stock (TPS) to mandated liability recognition

under FAS 150. As Fields et al. (2001) discuss, imperfections associated withincomplete markets provide demand for accounting-based contractual agreements.

As such, assessing the role of accounting information in financial contracts is of

primary importance. Bank debt agreements typically include financial 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) find that

financial covenants are set tightly so that they act as early warning tripwires that

trigger lender rights. Thus even firms that are not financially distressed are at risk of

violating covenants and being subjected to increased lender scrutiny. Beatty et al.

(2002) find that firms are willing to pay substantially higher interest rates to retainaccounting flexibility that might help them to avoid covenant violations. However,

empirical evidence has remained largely inconclusive on the relation between debt

covenants and financial reporting choices.2

The passage of FAS 150 in 2003 provides a natural experiment to investigate the

relation between debt contracting and financial reporting choices. Under FAS 150,

firms are required to recognize certain hybrid securities that previously qualified for

mezzanine reporting on the balance sheet as debt liabilities. This mandatory liability

recognition has the potential to adversely affect firms financial debt covenants. We

contribute to the literature by examining the economic responses of firms withoutstanding 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 financing for financial accounting purposes. Our findings suggest

that firms 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 financial contracting and its affect on shareholder

wealth.4

It is not clear, ex ante, whether reporting classifications should affect firms TPS

redemption decisions. There is a debate regarding the role that banks play as users

of financial 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 find evidence ofdebt markets creating a demand for financial reporting.2 Fields et al. (2001), Dichev and Skinner (2002), and Beatty and Weber (2003) provide discussions ofthe 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 preferredstock 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, wefind eight redeeming firms 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.

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biases in financial reporting since they can obtain information as a condition of

completing a transaction and proscribe bias-reducing contracts (Guay and Verrec-

chia2006). Under this view, the reporting classification for TPS is unlikely to affect

firms debt covenants (or, by implication, their responses to FAS 150) because the

treatment of particular securities can be specified in the debt contract. An alternateview is that changes in financial reporting do affect lenders performance

assessments via financial covenants because banks primarily contract on floating

Generally Accepted Accounting Principles (GAAP) (for example, Holthausen and

Watts2001; Watts2003; Ball et al. 2008).5

Our first prediction is that firms whose bank debt covenants are adversely

affected by the mandated reclassification of TPS as a debt liability under FAS 150

are more likely to redeem their TPS. To test this hypothesis, we first identify a

sample of firms with outstanding TPS and then collect actual debt contracts for all

of our sample firms both before and after the passage of FAS 150. If the debtcontracts use floating GAAP as the basis for defining financial 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 define debt or interest terms using fixed GAAP or specify the same

classification of TPS both before and after the passage of FAS 150, then there

should be no adverse effects. These firms 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 firms original purpose for raising capital withTPS. If a firm wanted to enhance its balance sheet, it could issue new TPS to retire

existing debt. By doing this a firm could, in effect, reclassify debt liabilities to the

mezzanine section of the balance sheet (between liabilities and equity).7 In contrast,

if a firm 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 firms 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 firms redeeming their outstanding

TPS after the passage of FAS 150. Figure1 presents data on the aggregate

outstanding TPS holdings of our sample firms from the initial introduction of TPS in

5 Floating GAAP refers to the use of current accounting rules to define financial terms, such that the

definition of financial terms changes along with subsequent accounting rule changes. Alternatively,fixed GAAP refers to the use of the specific GAAP rules that are in place when the contract is signed.Under fixed GAAP, the definition of financial terms does not change with subsequent accounting ruleschanges.

6 Several potential advantages of using floating GAAP include that it is less costly to monitor and thatit imposes fewer restrictions on corporate activities (see Smith and Warner 1979; Holthausen andLeftwich1983; Watts and Zimmerman1986).7 This reclassification as quasi-equity was not without some merit given some of the common features ofTPS, such as its long maturity term and allowance for deferred interest payments in the event of financial

distress.

Bank debt covenants and firms responses to FAS 150 liability recognition 357

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1993 through 2005. This figure shows a dramatic decline of $15 billion (or an

approximate 60% reduction) in TPS holdings during the 2003 to 2005 post-FAS 150period. Thus Fig.1provides 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 firms that are more likely to redeem their

TPS in the post-FAS 150 time period (2003 through 2005). For our first prediction,

we find that firms are significantly 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 firms with

affected covenants. For our second prediction, we find that firms are significantly

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 firms.

We supplement our empirical tests with descriptive data on the method of

redemption for those sample firms that redeemed TPS shares in the post-FAS 150

period. We find 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 firm specifically refinanced its TPS through

new debt issuances. These data are also suggestive of firms avoiding liabilityrecognition as a first-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

classification standards. First, our findings suggest that, when bank debt contracts

Fig. 1 Trust preferred stock. The figure reports the time series of outstanding trust preferred stock for allindustrial firms during the 1993 through 2005 sample period. We report the appropriate figures for allindustrial firms and for three subcategories of firms that are classified according to how the firm used theproceeds of the original trust preferred stock issue

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rely on floating GAAP to construct financial covenant terms, changes in the

underlying GAAP measures can significantly influence firms economic behavior.

In our setting, that translates into a greater likelihood of redeeming (id est,

refinancing) a financial security that is subject to mandatory reclassification as a

liability. This finding not only provides support for the importance of accountinginformation 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

classifications within the balance sheet affecting firms real capital structure

decisions.9 In addition to finding our primary debt covenant results within the

context of a mandated classification change, we find that firms that used the original

TPS proceeds to reclassify then existing debt to mezzanine financing were more

likely to redeem their TPS. These findings suggest that accounting classifications

within the balance sheet matter and provide support for the importance of currentstandard setting debates regarding the definition of a liability (FASB 2007).

The remainder of the paper proceeds as follows. Section2 discusses TPS securities

as the setting for our study. Section3develops hypotheses of firms redeem versus

reclassify choice. Section4 presents our sample and data. Section5 presents our

empirical model. Section6presents the results and Sect.7concludes the paper.

2 Trust preferred stock securities

2.1 Background and prior research

The first 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 financial and tax

reporting.10 Although the securities are treated as debt liabilities generating interest

deductions on the tax return, GAAP rules that were ineffect 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 findsthat reductions in market returns are positively correlated with increased tightness of debt covenants.Frankel et al. (2008) similarly find 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 finding complements prior evidence that changes in the short-term versus long-term classificationof 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 theproceeds to the parent company as a loan. Because the special purpose trust is included in the

consolidated financial statements, the inter-company loan is eliminated and the preferred stock is reportedon the balance sheet as mezzanine financing.11 We do not expect firms tax positions to significantly affect their redemption choices because thecorporate tax treatment of trust preferred stock as debt remains the same. We confirm this in sensitivitytests that indicate firms tax rates and excess foreign tax credit positions are not associated with their

redemption choices.


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classified as mezzanine financing 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 financing brought increased regulatory scrutinyand calls for more transparent financial reporting (McKinnon and Hitt 2002; Joint

Committee on Taxation2003).

Early studies of TPS generally focus on the initial years of TPS existence and

firms choices regarding the use of TPS proceeds. Engel et al. (1999) examine the

cost/benefit tradeoff for firms that use TPS proceeds to either retire debt or

traditional preferred stock. Specifically, they estimate the costs incurred by 44 firms

from 1993 through 1996 that retire debt with the proceeds of TPS issues and

conclude that, on average, the firms in their sample paid $3.9 million in

underwriting fees to reduce their debt ratios by 12.8%. They also examine 28firms that use TPS proceeds to retire traditional preferred stock and find 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 find mixed results.

Hopkins (1996) finds that balance sheet classification affects the stock price

judgments of buy-side financial analysts, while Krishnan and Laux (2005) find that

the market misprices the announcement of new TPS issues if there are no focal

benefits. Irvine and Rosenfeld (2000) focus on the use of TPS proceeds and stock

market reactions. They document positive abnormal returns surrounding TPS

announcements when firms use TPS proceeds to retire traditional preferred stock butfind no significant valuation effects surrounding TPS announcements when firms

use TPS proceeds to retire debt.

Taken together, these studies suggest that firms received substantive benefits

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 firms decisions to redeem their TPS after FAS

150 and the terms of their debt contracts.

2.2 Liability recognition under FAS 150

Concerns that firms were not reporting their debt obligations in a sufficiently

transparent manner led to the issuance of FAS 150 in May 2003. This new standard

significantly changed the treatment of TPS because firms were required to reclassify

their outstanding TPS shares as debt liabilities (generally as of the first interim

period beginning after June 15, 2003).12 Levi and Segal (2005) examine the

characteristics of firms issuing TPS around the enactment of FAS 150. They find

that prior to FAS 150, a firms decision to issue TPS is positively related to its debt

12 Although most firms in our sample cite FAS 150 as the underlying reason for reclassifying theiroutstanding TPS to the liability section of the balance sheet, some firms cite FASB Interpretation No. 46(revised December 2003 as FIN46R) requirements to consolidate variable interest entities as the basis for

their reclassifications.

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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 Compustatdata item to identify a sample of

mandatorily redeemable preferred stock and links changes in outstanding balances

to financial covenant characteristics. In an international context, MacKenzie (2006)and Carlin et al. (2006) find 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 firms TPS redemption decisions. Our study links

this decision to lenders reliance on GAAP classifications and to firms 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 firm 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 theirfinancial covenants. That is, their lending agreements contain financial covenants

that rely on debt or interest expense in their construction, and these terms are

defined in accordance with current or floating GAAP. Although bank contracts

can be tailored to the needs of the lending bank and the company, floating GAAP

is frequently reliedupon as a method that does not require adjustments to reported

GAAP numbers.14 With floating GAAP, the definition of debt follows current

balance sheet classifications such that TPS is not considered debt prior to FAS 150

but is considered debt after the implementation of FAS 150. We expect these firms

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) find evidence of firms continuing to issue TPS in the post-FAS 150 period,

while we find only one firm in our sample of industrial firms issuing TPS after FAS 150. This difference islikely due to the exclusion of regulated firms (financials and utilities) from our sample.14 Prior research explores instances in which lenders make adjustments to GAAP accounting. Forexample, Beatty et al. (2008) find an association between income escalators in net worth covenants andaccounting conservatism, while Li (2009) finds evidence of adjustments for transitory components in

contractual definitions of earnings and net assets.


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3.2 Original use of trust preferred stock proceeds

Much of the prior research on TPS focuses on the extent to which firms took

advantage of enhanced balance sheet reporting versus the tax deductibility feature of

the security. If a firm wanted to maximize its balance sheet reporting, the proceedsfrom the original TPS issuance could be used to retire existing debt. By using the

proceeds to retire existing debt, a firm could reclassify its debt liabilities to the

mezzanine section of the balance sheet (between liabilities and equity). At the other

extreme, if the firm 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, firms could use the proceeds

as a substitute for issuing additional debt or equity by using the proceeds to fundongoing general corporate needs. We test the prediction that firms 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 firms with outstanding TPS in 2002 (the year prior

to the enactment of FAS 150). To identify the sample, we use DirectEdgarto search

all 10-K filings 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 identified

using these search methods.

We eliminate financial firms (SIC 6000-6900) and public utilities (SIC4900-4999) from our test sample because the regulatory incentives of these firms

could confound the FAS 150 incentive results.15 Our initial sample contains 78

industrial firms with outstanding TPS between 1993 and 2005. Because our focus is

on firms incentives to reclassify or redeem TPS around the enactment of FAS 150,

we eliminate 14 firms that redeemed all of their outstanding TPS prior to 2002. We

match the remaining 64 sample firms to the mergedCompustatannual industrial file

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

firms with no Compustat information, yielding a final sample of 58 firms.For each of the 58 firms, we collect information on the firms stated use of the

original TPS proceeds, the issue amount, and redemption provisions. Following the

15 For example, the Federal Reserve ruled that TPS qualified as Tier 1 equity capital for banks in 1996,

and insurance companies are subject to capital adequacy requirements.

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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 firms disclose

material debt covenant agreements. We review the exhibits to the annual 10-K

filings because these covenants are typically reported in Exhibit 4 or Exhibit 10. Inaddition, we search the SEC website using a variety of search terms including

financial covenant, debt covenant, amended agreement, and credit agreement. Our

search yields bank debt covenant data for 54 of our 58 sample firms. For the

remaining four firms, we assume that there are no material debt covenant

agreements. In untabulated robustness tests, we also eliminate these four firms from

our empirical analysis and find 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

firms with financial covenants using debt or interest in their calculation (forexample, covenants potentially affected by liability recognition), we evaluate the

covenant definitions. In particular, we are interested in whether the definition of debt

or interest expense uses floating GAAP or fixed GAAP, explicitly includes

TPS, or explicitly excludes TPS.16

5 Empirical model

We examine whether mandated TPS liability recognition under FAS 150 influencedfirms redemption versus reclassification choice using the following general model:

Redeem fAffected Covenant; OIRetire 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

Redeemis a binomial variable that equals 1 if a firm redeems a majority of its TPS

in the period following the enactment of FAS 150 (2003 through 2005) and 0 if the

firm chooses to reclassify its outstanding TPS as a liability. We verify firms choices

by examining their 10-K filings in the years following the enactment of FAS 150.

Our review of firms filings after FAS 150 reveals that, of all the firms that did not

redeemtheir 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 includeTPS in the definition of debt in the covenant agreement.17 Kimberly-Clark issued TPS from its Luxembourg-based financing subsidiary. In turn, the Luxem-bourg-based financing subsidiary loaned 97% of the proceeds from the issuance to Kimberly-Clark at a

fixed rate of interest. In its annual report for 2004, Kimberly-Clark Corporation maintained that the


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during our post-FAS 150 test period. Based on our review of subsequent filings, we

conclude that all sample firms 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 firms

bank lending agreements and definitions of financial covenant terms relying on debt

or interest in their measurement. We code Affected Covenants as 1 for those firms

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 definition of covenant

terms allows floating GAAP to define debt (which would exclude TPS prior to

FAS 150 and include it after FAS 150), the variable Affected Covenantsis coded as

1. If, instead, the definition of the covenant terms is uniform before and after theenactment of FAS 150 (TPS was explicitly included in debt, TPS was explicitly

excluded from debt, or debt is defined using fixed GAAP) the variable Affected

Covenants is coded as 0.18 If the firms financial covenants do not specifically

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

coefficient on Affected Covenants.

We construct the variable OI-Retire Debtbased on the firms stated use of the

proceeds from the original TPS issuance. We classify each use of the proceeds into

one of three categories.OI-Retire Debtindicates that the proceeds from issuing TPSwere used primarily to retire existing debt.OI-Stockindicates 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 firms

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 coefficient on OI-Retire Debt.

5.3 Control variables

We also include the following firm-specific 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 fiscal year. LnMVE,

measured as the natural log of market equity, provides a general control for firm

size. Market-to-Book, measured as market value of equity to book value of equity,

Footnote 17 continuedforeign financing subsidiary with its fixed interest obligation should not be consolidated in its financial

statements. As a result, Kimberly-Clark continued to report its TPS in the mezzanine section of itsbalance sheet.18 We find two instances where firms negotiated with lenders in response to FAS 150. For example, DuraAutomotive negotiated a 2003 amendment to its debt covenant agreement that specifically excluded TPSfrom the definition of debt. Any measurement error resulting from our failure to find other renegotiated

covenant agreements should bias against finding results consistent with our hypotheses.

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controls for the firms growth opportunities. ROA, measured as pretax income to

total assets, controls for profitability. 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 coefficient on Debt Ratio if firms with higher leverage, onaverage, have fewer opportunities to refinance their TPS.

TPS/External Capital, measured as the outstanding balance of TPS to total

external capital, controls for the materiality of the firms 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 coefficient

on TPS/External Capital.

Finally, Non-Investment Grade, a dummy variable coded as 1 for firms with a

Standard & Poors debt rating below BBB- (or no rating), controls for the firms

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 coefficient on Non-Investment Grade.

6 Results

6.1 Summary statistics

As shown in Fig.1, our sample firms increasingly used TPS financing over theperiod 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 firms were motivated to make substantive changes to

their capital structure.

We present descriptive statistics for our sample of industrial firms in Panel A of

Table1. Out of 58 sample firms, 22 havedebt 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-Bookratios of 2.978, and

negative returns on assets (ROA) of-1.8%. In addition, our firms 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 firms are large, they tend to have low

profitability and do not have cost-effective access to public debt markets.

We also present summary statistics by the firms use of the original TPS proceeds

in Panel B of Table 1. Out of 58 sample firms, 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 firms that do not have Affected Covenants, 17 firms have debt covenant agreements thatspecifically included or specifically excluded TPS from the definition of debt or interest, 15 firms havedebt 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 firms are not subject to financial debt

covenants.


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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 1.000OI-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



OI-retire stock


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



OI-general purposes


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



This table reports summary statistics for our sample of 58 industrial firms with outstanding trust preferred stock prior to

the enactment of FAS 150.Affected Covenantsis a dummy variable coded as 1 if a firm has bank debt covenants that are

affected by the FAS 150 liability recognition and 0 otherwise.OI-Retire Debtis a dummy variable coded as 1 if a firm

used the proceeds of the original trust preferred stock issue to retire existing debt and 0 otherwise. MVEis the market

value of equity (Data25 * Data199). Market-to-Bookis 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 Ratiois 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 codedas 1 if the firm 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 classified

according to the firms use of the original issue proceeds

366 W. Moser et al.

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corporate purposes. On average, we find that those firms using TPS proceeds to

retire debt are larger ($5.8 billion) than firms using the proceeds to retire stock ($2.9

billion) or for general purposes ($3.03 billion). We also find 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 firms 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 firms redeeming (versus reclassifying) their TPS are more likely to have

Affected Covenants, IO-Retire Debt, and higher TPS/external capital. Fifty percent

of redeeming firms have bank debt covenants that are adversely affected by FAS

150, compared with 18.2% of reclassifying firms. This is consistent with ourhypothesis 1 prediction. We also find that 55.6% of firms in the redeeming sample

used the original TPS proceeds to retire existing debt versus 31.8% of firms in the

reclassify sample. Thus, the univariate results are also consistent with hypothesis 2.

We present a Pearson correlation matrix in Table3. 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 specification 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 alsohave some expected correlation. In particular, larger firms (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 Tstatistic

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 firms that redeemedtheir trust preferred stock (Redeem) in the 2003 through 2005 period following the enactment of FAS 150and firms that did not redeem their trust preferred stock (Reclassify).Affected Covenants,OI-Retire Debt,

MVE, Market-to-Book,ROA,Debt Ratio,TPS/External Capital, andNon-Investment Gradeare defined inTable1

***, **, and * denotes significance at the 1, 5, and 10% level, respectively


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Table3

Correla

tionmatrix

Redeem

Affected

covenant

OI-ret.debt

LnMVE

Market-to-book

ROA

Debtratio

TPS/Ext.

capital

Non-invmt

grade

Redeem

1.0

00

Affectedcovenan

t

0.3

18(0.0

15)

1.0

00

OI-retiredebt

0.2

19(0.0

98)

0.2

98(0.0

23)

1.0

00

LnMVE

-0.0

06(0.9

97)

0.0

82(0.5

39)

0.0

70(0.6

04)

1.0

00

Market-to-book

0.0

96(0.4

75)-0.1

47(0.2

71)-0.0

97(0.4

66)

0.2

51(0.058)

1.0

00

ROA

-0.1

61(0.2

27)

0.1

03(0.4

43)

0.0

57(0.6

73)

0.5

32(0.001)

0.3

12(0.0

17)

1.0

00

Debtratio

-0.0

27(0.8

40)-0.0

58(0.6

65)

0.1

09(0.4

14)-0.0

99(0.461)

0.0

45(0.7

37)

0.0

45(0.7

38)1.0

00

TPS/externalcapital

0.2

04(0.1

24)

0.0

13(0.9

21)

0.0

57(0.6

70)-0.3

69(0.004)

0.0

87(0.5

147)-0.2

68(0.0

42)0.2

56(0.0

52)1.0

00

Non-invgrade

0.0

17(0.8

98)

0.1

25(0.3

49)

0.0

16(0.9

04)-0.2

99(0.022)-0.2

88(0.0

28)

0.0

76(0.5

70)0.2

95(0.0

24)0.0

61(0.64

7)1.0

00

ThetablepresentsaPearsoncorrelationmatrixforoursampleof58industrialfirms.R

edeemisabinomialvariablecoded1ifthefirmchosetoredeemitstrustpreferred

stockin2003through2005periodfollowingtheen

actmentofFAS150(vs.reclassify

ingtheTPSasadebtliability).Af

fectedCovenants,

OI-RetireDebt,

MVE,

Market-

to-Book,ROA,D

ebtRatio,

TPS/ExternalCapital,andNon-InvestmentGradearedefinedinTable1.

P-valuesarepresentedinparentheses

368 W. Moser et al.

1 3


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sources (TPS/External Capital), and greater access to investment-grade public debt

(Non-Investment Grade).

6.3 Multivariate analyses

We report three specifications of our logistic regression in Table 4. Models 1 and 2

include Affected Covenants and OI-Retire Debtas separate terms, respectively. In

Model 3, we include both terms to test for incremental effects. Model 1 has a pseudo

R2 of 19.10% and a correct prediction rate of 78.3%, while model 2 has a pseudo R2

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 firms redeem

versus reclassify choices. Model 3, which includes both Affected Covenants andOI-Retire Debt, has the highest explanatory power with a pseudo R2 of 23.0% and a

correct prediction rate of 80.8%.

When included separately, the coefficients 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

PseudoR2 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 firms, 36 of which chose toredeem. The dependent variable, Redeem, is a binomial variable coded 1 if the firm chose to redeem itstrust 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/ExternalCapital, and Non-Investment Grade are defined in Table1. Elasticity Estimates for Affected Covenants

(in model 1) are computed as the difference in probability of havingAffected Covenants, estimated usingmodels withAffected Covenants =0 versusAffected Covenants = 1 while holding other variables at themean values. Elasticity Estimates for OI-Retire Debt (in model 2) are computed as the difference inprobability of havingOI-Retire Debt, estimated using models with OI-Retire Debt= 0 versusOI-Retire

Debt=1 while holding other variables at the mean values. Tstatistics are in parentheses below eachcoefficient estimate



1 3


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significant. We estimate the elasticity of each variable and find that the probability

of redeeming TPS increases by 26.88% for firms with Affected Covenants and by

22.35% for firms that used the original TPS proceeds to retire debt (OI-Retire Debt).

In the combined estimation (model 3), only Affected Covenants is significant. Our

regression results are consistent with both hypotheses 1 and 2 and with AffectedCovenants providing the dominant effect.

The results for the control variables provide some evidence that the probability of

redeeming TPS declines with profitability (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 firm size

(LnMVE) and the probability of redeeming TPS.

Overall, our results provide evidence of the importance of balance sheet

classifications for firms with binding debt contracts and their willingness to make

substantive capital structure changes in response to the new reporting requirementsof FAS 150.

6.4 Supplemental test variable specification

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 firms 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 floating or fixed GAAP as the basis fordefining the debt or interest terms. In effect, this alternative specification provides

evidence on the importance of identifying the specific 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 Table5. The coefficient on Financial Covenants (0.809, t statis-

tic = 1.17) is positive but insignificant. 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 firms redemption choices and their underlying incentives,

we also report supplemental data on the method of redemption in Table6.

Specifically, we examine the 10-K filing disclosures of the 36 redeeming firms to

confirm the method and dollar value of their redemptions. Based on these

disclosures and corroborating cash flow statement data, we partition the source of

the redemption funds into four categories: issue/convert to common stock, cash flow

from operations, issue new debt, and multiple sources.The method of redemption is explicitly stated in the footnotes to the financial

statements for the 18 firms that financed 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.

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Table 5 Supplemental logistic regression usingFinancial 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

PseudoR2 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 firms, 36 of which chose toredeem. The dependent variable, Redeem, is a binomial variable coded 1 if the firm chose to redeem itstrust preferred stock in the 2003 through 2005 period following the enactment of FAS 150 versusreclassifying the TPS as a debt liability and 0 otherwise. Financial Covenantsis a dummy variable codedas 1 if a firm has bank debt covenants that include debt or interest in their terms. In contrast toAffectedCovenants,Financial Covenantsmakes no attempt to distinguish covenant terms that are actually affectedby FAS 150 due to the use of floating GAAP.MVE, Market-to-Book,ROA,Debt Ratio,TPS/External

Capital, and Non-Investment Grade are defined in Table1. T statistics are in parentheses below eachcoefficient estimate


Table 6 Redemption method

Number $ Millionredemption

Number whereOI-retire debt

$ Million whereOI-retire debt

Issue/convert to common stock 18 7,083 9 5,023

Cash flow 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 firms that redeemedtheir 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 preferredstock. The categories are (1) issue/convert to common stock, (2) cash flow from operations, (3) issue newdebt, and (4) multiple sources. For each category we report the number of TPS redemptions and thecorresponding dollar amount (in millions) of trust preferred stock redeemed. We also report statistics for asubcategory of redeeming firms that used the proceeds of the original trust preferred stock issue to retireexisting debt (OI-Retire Debt)


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million in annual interest deductions with a potential tax cost of $173 million.20 For

the remaining 18 redeeming firms (id est, those that did not redeem using only

common stock), we use data from the cash flow statements to determine available

funding sources. It appears that only one of these firms would be required to issue

new debt to finance its TPS redemption. This is consistent with firms minimizing theconsequences of liability recognition rather than simply replacing a less attractive

security with other sources of lower cost debt.

Our finding that some firms chose to redeem their TPS rather than renegotiate with

lenders suggests that these firms either could not amend their debt contracts or faced

higher relative renegotiation costs. Prior research suggests that the cost of negotiating

flexibility in debt contracts can be large. Beatty et al. (2002) find evidence that firms

pay substantially higher interest rates to retain accounting flexibility that may help

them avoid covenant violations. Recent studies in financial economics (for example,

Roberts and Sufi 2009) further cite amendment fees, the bargaining power of borrowersto switch lenders, costs incurred in the form of time and effort, and macroeconomic

fluctuations in credit and equity markets as significant factors that affect renegotiation

costs.21 Overall, our results suggest that firms adversely affected by FAS 150 liability

recognition incurred significant costs to mitigate the effects on their debt contracts.

7 Conclusions

The passage of FAS 150 in 2003 provides a natural experiment to investigate therelation between debt contracting and financial reporting choices. FAS 150

mandated that certain securities (for example, trust preferred stock) be reclassified

from mezzanine financing to debt liabilities. Although firms have economic

incentives to avoid covenant violations (Watts and Zimmerman 1986, 1990),

empirical evidence is largely inconclusive on the relation between financial

covenants and accounting choice. We contribute to this literature by examining the

relation between financial covenant restrictions and firms choice to redeem or

reclassify their outstanding TPS following the enactment of FAS 150.

Our findings suggest that bank debt covenants significantly affect firms

economic responses to a mandated accounting change. For firms with bank debt

covenants that are adversely affected by the mandatory accounting change, we find

a 26.88% increase in the probability that the firm will redeem its TPS. We also

provide evidence that a firms original use of TPS proceeds affects its redemption

decisions in the post-FAS 150 period. Specifically, firms 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 thebenefits 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 Sufi (2009) find that renegotiations are highly pro-cyclical and that the terms of therenegotiation are significantly more favorable for the borrower during periods of economic expansion.This finding is particularly relevant for firms in our sample since bank loan renegotiations would haveoccurred 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.

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Our study makes several contributions to the existing literature. First, our

findings suggest that when bank debt contracts rely on floating GAAP in their

construction of financial covenants, changes in the underlying GAAP measures can

significantly influence firms economic behavior. Second, our results are consistent

with accounting classifications within the balance sheet affecting firms real capitalstructure decisions. Finally, we provide support for the importance of current

standard setting debates regarding the definition of a liability.

Acknowledgments We would like to thank Richard Sloan (the editor), two anonymous referees, andseminar participants at the University of Missouri, Texas A&M, and the 2007 American AccountingAssociation annual meeting. This paper was presented at the 2007 American Accounting Associationannual meeting with the title Debt Covenants, Balance Sheet Classification, 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 millionaggregate 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 financial 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 fixed for redemption.

Dillards

6. Guaranteed Preferred Beneficial Interests in the Companys Subordinated

Debentures


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Guaranteed Preferred Beneficial 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 beneficial

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 plus1.56% 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 definitions in bank lending agreements

United Rentals Inc

Specifically 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 definition 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

Specifically 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.

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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 issubject 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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bank debt covenants and firms’ responses to fas 150 liability recognition. evidence from trust...

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