Why Do Firms Issue Hybrid Bonds?

Abstract

This study examines why firms issue hybrid bonds. We exploit a novel setting that allows us to test whether firms consider IFRS-based leverage and/or credit ratings when issuing a hybrid bond. Conditional on their structure, hybrid bonds can be classified as debt or equity under International Financial Reporting Standards (IFRS) and/or by credit rating agencies. Unrated firms issue hybrid bonds classified as equity under IFRS if their IFRS-based leverage is higher. Rated firms issue hybrid bonds classified as equity by credit rating agencies if their credit rating is at risk and when their credit rating deteriorates. Rated firms exploit the structuring opportunity that hybrid bonds offer. Drawing on the debt contracting value of accounting information and credit ratings, we expect and find rated firms with stronger credit ratings to issue hybrid bonds classified solely as equity by credit rating agencies but as debt under IFRS. Conversely, rated firms with a weaker credit rating and higher default risk as proxied by accounting-based indicators issue hybrid bonds classified as equity by both IFRS and credit rating agencies. Unrated and rated firms are willing to incur considerable costs when choosing to issue a hybrid bond, suggesting that firms perceive substantial benefits associated with equity classification under IFRS and/or by credit rating agencies.

Keywords: Capital structure, Credit ratings, Debt, Equity, Hybrid bond, Hybrid instrument

JEL Classification: G24, M41, G32