Hybrids, Expensive Debt or Cheap Equity?
Hybrids are financial instruments that combine certain elements of debt and equity. Examples are preferred equity, convertible bonds, subordinated debt and index-linked bonds. For the issuers, hybrid securities can combine the best features of both debt and equity: tax deductibility for coupon payments, reduction in the overall cost of capital, and a strengthening of senior credit ratings.
This article describes the reasons behind the increased interest among corporates in using hybrid instruments to optimize their capital structure and the impact of hybrids on the WACC and shareholder value. It also takes a look at treatment by accountants, tax regulation and rating agencies.