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Implied Fixed Costs of Long-Term Debt Issues

Published online by Cambridge University Press:  19 October 2009

James C. Van Horne
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Extract

In this paper, a model is developed for deriving the implied fixed cost of a bond flotation. Using a sample of electric utility companies over the 1961–1970 period, implied fixed costs are computed for 318 bond issues. These fixed costs then are evaluated in an effort to cast light on whether companies behave optimally with respect to the size and frequency of bond issues. Regression results are consistent with the adjustment of debt issuing behavior in keeping with: (1) expectations about the future course of interest rates; (2) variable costs increasing at a decreasing rate with the size of individual issue; and (3) differences in the cost of carrying excess liquidity which arise from differences in quality rating. An estimate of the average fixed cost of issuing bonds is evaluated as is the debt issuing behavior of individual companies. Over all, the model and its testing give considerable insight into the implied fixed costs of issuing debt.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 8 , Issue 5 , December 1973 , pp. 821 - 833
Copyright
Copyright © School of Business Administration, University of Washington 1973

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References

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