Why companies choose hybrid financing?

Abstract

2018 has been a record year for the hybrid issuing, whether there were contingent convertibles or other equity related securities, more than 22 billion € were issued. Thisis still a lower amount compared to what is issued on the capital or debt market, but it is increasing. Hybrids appear on the liabilities side, but due to their double nature, part equity and part debt, their definition may vary from one actor to another. For example, credit entities may consider hybrids more as debt, and on the contrary equity investors may consider them more as capital but of course it also depends on the conditions fixed at issuance and the characteristics of the instrument. In any cases this kind of instrument can be used for a diversification purpose in a portfolio and in a capital structure. The objective of this thesis is to explain why it could be interesting for companies to issue this kind of securities and how to price them. How their double characteristics, mixing equity and bond attributes, allows companies to reduce their costs of financing while having the possibilities to increase their capital if needed. Also, how it affects the value of a company as different definitions lead to different valuations, and so the prices of the securities may be affected and modified. And finally, what could be the impact in an M&A transaction and a context of financing young companies like in the venture capital market or nonquoted companies. From the point of view of the investors, are the advantages higher than the risks? Does the yield offered always compensate for the embedded risk? We see large-cap issuing a lot of hybrids, but isn’t it even more interesting to see that small-cap and mid-cap use this method to circumvent rules and ratings they are affected by when issuing bonds, then what will be the aversion to risk of the investor? It will also be interesting to see how the hybrids are regulated, with Basel III and the recent changes in capital requirements, their position and nature can offer an advantage for companies and banks with strict requirements.