Do Hybrid Instruments Lower the Firm Cost of Capital?
5 Pages Posted: 15 May 2006
Date Written: 2006
The issue of hybrid instruments by firms is often justified on the grounds that these instruments allow issuers to achieve a lower cost of capital than would be the case under issues of straight debt and equity. In order to assess the validity of such claims it is necessary to examine the economic impact of hybrid instruments on the issuing company. If a firm can genuinely achieve a lower cost of capital than would otherwise be the case with the issue of either straight debt or equity, we argue that this is directly linked to regulatory (reporting) arbitrage, rather than the outcome of financial synergy that arises when debt, equity and option instruments are combined to form a hybrid security. We evaluate the argument that hybrid structures lower the cost of capital from an opportunity cost and risk perspective. We focus our analysis on two main structures: convertible debt and reset preference shares.
Keywords: hybrid securities, cost of capital, regulatory arbitrage
JEL Classification: G20, G30, M40
Suggested Citation: Suggested Citation