A survey of US corporate financing innovations: 1970–1997

Journal of Applied Corporate Finance · 2023

• Business
• Finance
• Financial system

An appropriate subtitle for this article might well be “The Evolution Lives! Long Live the Evolution!” Previous articles in this journal have described innovations in financial security design and the forces that give rise to such innovations.1 In this article, we expand upon and update those articles by documenting changes over the past 30 years in the way US public corporations finance themselves both in public and private security markets.2 The past articles have focused mainly on innovations in the kinds of securities issued. But major changes have also occurred in the way securities are issued, and in the national markets where they are issued. Traditional registered offerings have been partly displaced by shelf registered offerings and Rule 144A private offerings. And once exclusively domestic US offerings are increasingly being supplemented by foreign market offerings by US companies, and by simultaneously domestic and foreign offerings. In the research summarized in this article, we tracked not only the kinds of securities (both by number and by dollar amount) issued each year by US public companies between 1970 and 1997, but also their method of issuance and the locale of the offerings. In a 1992 article in this journal entitled “An Overview of Corporate Securities Innovation,” John Finnerty traced innovations (through the first half of 1991) in the design of securities issued by US corporations by identifying the year in which the design first appeared.3 Our study extends that article's findings in two ways: (1) by updating developments in the design of corporate securities through the end of 1997 and (2) by presenting an annual time series of security issues classified according to the design of the security from 1970 through 1997. Our updating of new developments in security design provides clear evidence that the pace of innovation in securities design has not slackened. For example, whereas Finnerty identified 40 types of securities that were first issued by US companies in the 1980s,4 our study found 34 kinds that were first issued during the first eight years of the 1990s.5 Among these securities were equity indexed bonds, commodity indexed preferred stock, convertible exchangeable notes, and dividend enhanced convertible securities. Our study also attempted to identify which innovations have prospered over time and which have languished or even disappeared. For example, the first non-convertible floating rate note (FRN) was issued in 1974. The use of FRNs increased steadily throughout the next 24 years and, in 1997 alone, US public companies issued 1411 FRNs with an aggregate face value of $139.8 billion. By contrast, after the first convertible adjustable rate bond (CARB) came to market in 1981, 10 additional CARBs were issued during the remainder of the 1980s, and none have been issued since. Our findings suggest that financial innovation is a trial and error process in which “failure is more likely than not.”6 Publicly traded US companies can issue securities exclusively to US investors, exclusively to non-US investors, or simultaneously to US and foreign investors. The three panels of Table 1 display the number and dollar amount of security offerings for each year from 1970 through 1997. Panel A shows public and private offerings in the United States; Panel B shows public and private offerings made simultaneously in the United States and one or more foreign country; and Panel C reports offerings made in one or more foreign countries. Before describing the different types of securities issued, we focus on the data in Table 1 to provide an overview of offerings in the aggregate by offering technique and locale. Within the US market, securities can be issued in either the public or private market. Any security that is registered with the SEC is considered to be issued in the public security market. Unregistered securities are considered to be issued in the private security market. Prior to March of 1982, once a company had decided to issue a security in the public market, the company prepared and filed with the SEC a registration statement and prospectus describing the terms of the security and the dollar amount of funds to be raised. The company then waited for completion of an SEC review before issuing the security. In March of 1982, the SEC implemented Rule 415. Under Rule 415, public companies that meet certain size and credit requirements are allowed to register a “generic” statement with the SEC. This generic registration statement (form S-3) includes the company's basic financial information and the amount of securities the firm expects to issue within the next two years, although the life of the registration statement is indefinite. At the time the company decides to issue a specific security, the company is required to file a prospectus supplement that discloses the specific terms and dollar amount of the security to be issued and incorporates by reference other financial information filed by the company with the SEC. Upon filing this information, the security can be issued. This procedure is popularly known as shelf registration because, in effect, the issuer puts its new securities “on the shelf” until the funds are actually needed. As shown in Panel A of Table 1, in 1983 shelf registered issues accounted for 20% of the number of securities offered and 37% of the total dollar amount of funds raised in public offerings. In 1997, shelf registered offerings accounted for 49% of the securities issued and 46% of the dollar amount of funds raised in the public market. A similar transformation occurred in the private security market with the introduction of Rule 144A in 1990. Securities issued in the private security market cannot be traded on an organized exchange. Furthermore, prior to Rule 144A, the original investor in an unregistered security could not trade the security in any venue for at least two years. Following that two-year period, the security could only be traded among “sophisticated” investors. Rule 144A allows unregistered securities to be traded among “sophisticated” investors immediately after issuance. According to SEC guidelines, a sophisticated investor is one who has the capacity to (1) evaluate the risk and return characteristics of the security and (2) bear the financial risk contained in the security. As shown in Panel A of Table 1, in 1991 Rule 144A offerings accounted for 13% of the number of private securities issued and 19% of the total dollar amount of funds raised in private offerings. In 1997 Rule 144A offerings accounted for 64% of the securities issued privately and 83% of the dollar amount of funds raised in the private market. Panel B parallels Panel A in that offerings made simultaneously in the United States and one or more foreign countries are classified according to whether the offering is public or private and whether it is a shelf or 144A offering. This panel illustrates that, although simultaneous offerings have grown over time in both absolute number and dollar amount, they still amount to only a modest fraction of purely domestic offerings. In 1997, the $855 billion raised by US public companies through purely domestic offerings was 18 times the $47 billion raised through simultaneous offerings. Additionally, this panel illustrates that the growth in shelf and 144A simultaneous offerings mirrors that shown in Panel A. In Panel C, offerings made outside the United States, (starting in 1983, the first year for which SDC data are available) are classified according to whether they are denominated in US dollars or a foreign currency. To expand the geographic scope of their offerings, US companies can offer securities in international markets exclusively or they can simultaneously issue securities in both domestic and international markets. Total international market offerings grew quickly during the mid-1980's, slowed during the late 1980s and early 1990s, and have shown continued growth in the mid-1990s. In 1997, US companies raised $58 billion in 306 bond issues outside the United States. When international offerings are combined with simultaneous offerings, the volume of these offerings totaled $105 billion, or 11% of the total funds raised by US corporations in that year. Besides expanding the geographic scope of their securities offerings, US companies have also changed their currency denomination. In the 7 year interval from 1983–1989, US corporations raised $93.4 billion in US dollar-denominated international market offerings, but only $39.1 billion in non-US denominated issues. Then, for the first time, in 1990 the volume of foreign currency denominated international offerings exceeded dollar-denominated overseas issues. And, from 1990 to 1997, the $237 billion raised by international offerings has been almost equally divided between foreign-currency and dollar-denominated issues. Of the total amount issued in 1997, 54% were denominated in a currency other than US dollars. Why the growing use of foreign-currency debt? For companies with significant international revenues, issuing debt with interest and principal denominated in matching currencies can reduce cash flow volatility stemming from exchange rate movements. In tracking the process of securities innovation, we started by classifying all securities employed by corporate issuers since 1970 into six generic categories: (1) common stock, (2) non-convertible debt, (3) convertible debt, (4) non-convertible preferred stock, (5) convertible preferred stock, and (6) asset backed securities. Then, within each of the six categories, all securities were identified as either “traditional” or “innovative.” For our purposes, a traditional non-convertible debt is any callable or noncallable non-convertible bond or note with a fixed periodic cash coupon payment, a fixed final maturity date, and fixed repayment schedule. A traditional convertible debt is defined similarly, except that the security is convertible into the common stock of the issuer at the option of the investor. Convertible and nonconvertible bonds or notes with any other feature are categorized as innovative. A traditional non-convertible preferred stock is any callable or noncallable non-convertible preferred stock with a fixed periodic cash dividend and no fixed maturity A traditional convertible preferred stock is defined similarly, except that the security is convertible into the common stock of the issuer at the option of the investor. Convertible and non-convertible preferred stock with any other feature are considered innovative. securities not into our of the of a “traditional” by all are innovative. all common of their are as The of our are in Table In of the securities issued, only offering of coupon convertible classified as innovative. the 1970 through of issues are identified as innovative. as we into the 1980s, the pace of innovation to In of 13% issues are classified as innovative. And, in 1997, of the issues into the in dollar billion of the billion raised through all 1997 offerings were accounted for by securities. The fraction of securities classified as traditional and securities the six generic As we are no securities in the common stock and are no traditional securities in the Among debt traditional offerings offerings year in both number and dollar In 1997, the billion of traditional non-convertible and convertible debt offerings was times the billion issued in debt securities. In the of preferred by contrast, are years in which offerings traditional offerings. and 1997, billion in and convertible preferred stock issues as issues only billion as traditional issues. The of preferred stock securities of are not an in the of preferred stock issues to traditional preferred stock issues. In to their preferred stock innovations and also feature dividend that reduce volatility for investors and issuers to interest rate An innovation in the design of a security one of the basic of the security is According to our a traditional debt security has a fixed periodic in US a fixed repayment in US and a fixed maturity A in any of these rise to an security. For example, the fixed periodic is denominated in a foreign a new security has been in the of preferred stock, any security that from a fixed periodic dividend in US or from a a new security. For example, the dividend is to commodity or the investor the life through a a new security is In securities a of changes in the basic of the security. For example, a floating rate bond both the periodic it with the of interest and the maturity investors with the option to the bonds to the firm before corporations issue these new securities to the issuers or investors to they could not with to but at such as debt, have been to reduce financial interest corporate cash are to be and to to market investors risk in who are to bear such as asset to investors more for example, and securities also be to meet the combined of the issuer and the investor. For example, securities such as coupon bonds and preferred stock have been to reduce the combined of the issuer and the investors. innovations can be to in a might have required For example, a currency bond a fixed rate bond and a on foreign exchange. through the number and dollar of the different types of non-convertible debt convertible debt non-convertible preferred stock and convertible preferred stock In each the securities are classified according to their specific security issued is only the are to be For example, Table a rate and floating rate a floating rate note is also an it is not in the floating rate note in to issued issued issued issued issued issued issued issued issued issued issued issued The common of the fixed periodic is to the to an such as interest or foreign exchange For example, floating rate notes have coupon that a specific interest rate such as a that the risk of the issuer and the of the security. rate preferred stock and rate notes the coupon or dividend to the market interest rate through a process of periodic preferred stock and notes use a to the coupon or dividend to the market interest As of exchange principal exchange rate securities have coupon that are to foreign currency exchange and in US and currency bonds have coupon principal denominated in a currency other than US dollars. rate and exchange rate securities can the investor and the issuer to their asset and more as to reduce the volatility of cash the volatility of cash reduce and financial as well as from of interest between and in securities floating and securities reduce cash flow volatility by interest rate In similar exchange securities and currency bonds can provide a for who are in international than issuing a currency companies could the by issuing bonds in the foreign market. rate and securities also reduce investor and information by interest to for changes in the credit As the credit each of these securities the And, although such a can end it the credit the firm the securities are innovations in bond design the of any periodic in coupon that or over time in a and in an asset other than cash and to the credit of the issuer coupon bonds, coupon convertible bonds, and option notes have no until the maturity at maturity both the principal and interest are in a The coupon rate for fixed rate notes by a amount at a In the of floating rate notes, the an interest rate at a the for securities. notes and preferred stock provide the issuer with the option of coupon or dividend either in cash or additional securities. bonds an in coupon the credit also the to issue a new security. Prior to the of the and of 1982, the US allowed an issuer of coupon bonds to the original on a for This feature allowed corporations to interest for at a rate than interest actually on the The that corporations interest as it actually the number of coupon bonds issued to A innovation is the preferred stock categorized in Table as preferred stock and preferred The innovation with the preferred has to with the of the offering more than the of the security. In with preferred a company a that issues preferred The from the preferred stock offering are to a bond issued by the and the interest on the debt are by the this the the of preferred stock with the of interest on traditional of financial can from issuing that not cash such as coupon bonds, preferred stock can be or cash until maturity with any of these issuers with growth but cash flow to that growth a or equity Of the in such be more to the credit additional risk from to in an of credit risk or interest the market the issuer can the interest in additional securities. The issued securities have the maturity and coupon as the security. the market value of the securities is than the value the number of additional securities to meet the interest A bond or preferred security changes the periodic payment, but its is on the maturity of the security. A security the interest rate on fixed rate securities the in the of floating rate to the interest a with the feature provides the firm with to the bond or preferred stock, since the interest on such securities are likely to be market in the early of the life and in through the and of securities that the periodic The evidence that innovations have have and still have To date, the employed innovation has been the floating rate For during the a total of FRNs were issued, a total of billion in the 1980s, FRNs raised of and in the first eight years of the 1990s, issues accounted for a total of billion in other security to either the volume or with floating rate In contrast, the use of coupon bonds, coupon convertible bonds, and notes has been but For with the of and 1997, the number of coupon bond issues has not exceeded since they were in The use of coupon convertible bonds and notes has exceeded eight in any one year. the use of rate preferred stock, principal exchange rate and convertible adjustable rate preferred stock has over the number of rate preferred stock issues has from six first in to a of issues in to or offerings during The use of principal exchange rate securities and convertible adjustable rate preferred stock has exceeded issues in any year since their introduction and no issues have been made during the years. According to our traditional debt has a repayment in US dollars and a fixed maturity Traditional preferred stock has Any of these give rise to an debt security or preferred Securities changes in the repayment securities that can be for security of the issuer as exchangeable preferred stock and convertible securities that can be for a security of a company other than the issuer commodity securities indexed preferred and stock securities For exchangeable preferred stock and convertible exchangeable preferred stock provide the issuer the option to exchange the securities for a bond with similar convertible preferred stock and convertible bonds that the preferred exchange the security for the common stock at the maturity debt allows the investor to the security into the stock of a but not that of the indexed preferred securities a fixed dividend and have a principal value that is to the value of a and notes the principal amount interest the of the value over the value of the times securities give the issuer the to time to issue debt or preferred stock the of For preferred stock has a to debt interest is preferred are preferred stock has one for corporate of are as to the of the is through to the issuer by the of corporate investors to a dividend The of is for a or a to issue preferred the rate in the exchangeable preferred stock the issuer to the preferred stock with notes on which the interest are for issuers that have a rate and a in the exchangeable notes provide the issuer the option to the note with preferred stock that has the terms and dividend as the The feature also the The feature can value by of interest between and that can the of corporate and The feature provides with the that they in any in value that from an in the Furthermore, by interest reduce the that cash companies be to convertible bonds as and convertible preferred stock are similar to other convertible except that into the common stock is required at and reduce the since the into the common stock even the value is than the a life for the security that allows it to be as equity for and of the maturity bonds that not as floating rate bonds that provide the investor with the option to the security to the issuer and bonds with the option to the life of the security In the of floating rate notes, the security has an life and the coupon is to an interest rate bonds and convertible bonds either a or a The provides the investor with the option to the security to the issuer at a specific and time prior to the maturity In contrast, the the which the security can be to the issuer the number of securities that can be to the issuer at a bonds and convertible bonds the to the life of the security. bonds and bonds provide investors with interest and the from or a The can be as an option on changes in the as well as on changes in interest When interest or credit bonds with a option than bonds a When the bond the value interest the investor can the bond to the issuer at a fixed the firm can meet the cash flow are to the firm is to meet the cash flow the firm is to or When to an bond is the as a For example, a bond with an feature for an additional years is the as a bond with an option to the at the end of the year. In either the coupon rate on the bond not the required return for a security with the risk and investors return the bond to the at the end of the year. into a security. are coupon securities. The and feature each have an on the repayment and the maturity of The coupon feature the periodic the and feature the final maturity and final Among securities that the repayment and maturity the use of bonds has increased since they were in In the US corporations bonds issues that raised a total of In the 1980s, were issues of bonds billion in 1990 to 1997, bond issues have raised billion. By the use of exchangeable preferred stock and convertible preferred stock has been but security has exceeded issues in any And the use of convertible exchangeable preferred stock and bonds has over In the 1980s, were issues of convertible exchangeable preferred stock billion in 1990 to 1997, convertible exchangeable preferred stock raised billion. In the 1980s, bonds were issued for billion, as to only issues for billion in the In Table we the number and dollar of classified by asset a market that the can of in or and the securities through a process For corporations with a credit be to reduce on that The credit of the of securities is on the not the credit an issuer from issuing a security with a credit that is to its The of is new in US corporate financial markets. were in that time, this market has grown from issues to issues in 1997 billion to billion in The types of to these securities have also increased over this For in only and were By 1997, were different of of and equity the market. In 1997, these three accounted for of the that were these issues raised billion of the billion raised in the security market. This article the of traded US corporations in public and private security markets from 1970 through 1997. significant changes during this time in the method of issuance registered offerings, shelf registered offerings, private offerings, and Rule 144A private the national locale of the offerings simultaneous domestic and foreign market and the kinds of securities issued. The Securities implemented Rule in and Rule 144A in 1990. on these new have been In 1997, half of all offered securities were issued as shelf registered offerings. Of private market offerings made by US corporations in 1997, Rule 144A offerings accounted for 83% of The of markets is also In 1997, 11% of all raised by US corporations were issued in one or more foreign markets. Of the $105 billion raised in these offerings, billion was denominated in currencies other than the US For corporations with foreign currency cash foreign currency debt provide a exchange rate traded US corporations have different of securities to over in the domestic markets. traditional securities still the market, our research that the pace of financial innovation increased during the 1980s and has continued throughout the In 1997, the issues of securities accounted for almost of total domestic and these issues raised 37% of the total from all US offerings. of the common of security design have been to (1) the interest rate other financial risk by investors and (2) to reduce information by investors securities from issuers with information their known as information and to (3) the of financial coupon such as those in floating rate notes are the common to reduce both the interest rate risk by investors and the interest to the securities for of all issues and of between 1970 and 1997. such securities to interest rate risk from the investor to the issuing issuers have a in such those to with and interest and security, notes or bonds in 1997 raised billion, or of total from also to by to their bonds to the But a more for investors is the securities offer a of the credit In this securities issuers to the information from investor the of securities innovation, has also been by issuers to reduce information have grown with from billion in to billion in 1997 of security the process a of into a security, the of are on the cash and risk of the asset not on the cash flow of the issuing Besides investor in this asset also value by the of financial the of financial reduce required of return and In US markets in the 1980s and were by both innovation and securities have languished or even have As securities to be to meet the specific of issuing and investors, we of the markets and continued growth in the and dollar volume of securities.