In this thesis we provide insights into the behavior of financial managers of utility companies
by studying their decisions to redeem callable preferred shares. In particular, we investigate
whether or not an option pricing based model of the call decision, with managers who maximize
shareholder value, does a better job of explaining callable preferred share prices and call
decisions than do other models of the decision. In order to perform these tests, we extend an
empirical technique introduced by Rust (1987) to include the use of information from preferred
share prices in addition to the call decisions.
The model we develop to value the option embedded in a callable preferred share differs
from standard models in two ways. First, as suggested in Kraus (1983), we explicitly account
for transaction costs associated with a redemption. Second, we account for state variables
that are observed by the decision makers but not by the preferred shareholders. We interpret
these unobservable state variables as the benefits and costs associated with a change in capital
structure that can accompany a call decision. When we add this variable, our empirical model
changes from one which predicts exactly when a share should be called to one which predicts
the probability of a call as the function of the observable state. These two modifications of the
standard model result in predictions of calls, and therefore of callable preferred share prices,
that are consistent with several previously unexplained features of the data; we show that the
predictive power of the model is improved in a statistical sense by adding these features to the
model.
The pricing and call probability functions from our model do a good job of describing call
decisions and preferred share prices for several utilities. Using data from shares of the Pacific
Gas and Electric Co. (PGE) we obtain reasonable estimates for the transaction costs associated
with a call. Using a formal empirical test, we are able to conclude that the managers of the
Pacific Gas and Electric Company clearly take into account the value of the option to delay
the call when making their call decisions. Overall, the model seems to be robust to tests of its
specification and does a better job of describing the data than do simpler models of the decision
making process.
Limitations in the data do not allow us to perform the same tests in a larger cross-section
of utility companies. However, we are able to estimate transaction cost parameters for many
firms and these do not seem to vary significantly from those of PGE. This evidence does not
cause us to reject our hypothesis that managerial behavior is consistent with a model in which
managers maximize shareholder value. / Business, Sauder School of / Graduate
| Identifer | oai:union.ndltd.org:UBC/oai:circle.library.ubc.ca:2429/8434 |
| Date | 11 1900 |
| Creators | Carlson, Murray |
| Source Sets | University of British Columbia |
| Language | English |
| Detected Language | English |
| Type | Text, Thesis/Dissertation |
| Format | 5596933 bytes, application/pdf |
| Rights | For non-commercial purposes only, such as research, private study and education. Additional conditions apply, see Terms of Use https://open.library.ubc.ca/terms_of_use. |
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