In this article we examine the determinants and consequences of the accounting classification of hybrid financial instruments as equity or liability. Accordingly, credit rating agencies rate CHBs as a mix of equity and debt (usually as 50% debt and 50% equity), regardless of their accounting classification.
Announcement returns of hybrid bonds (H2)
However, with regard to the accounting classification of CHBs, reporting incentives are likely to be more important than non-reporting incentives. Previous research provides robust evidence on several abnormal return patterns for the announcement of common debt and seasoned equity issues.
Value relevance of hybrid bonds and accounting transparency (H3)
To ensure the validity of our CHB sample, we manually check each of the 520 identified bonds whether the bond was issued by the indicated firm in the corresponding fiscal year and whether the bond is classified as equity or debt in the firm's financial statements. For 84 bonds, we are unable to verify the accounting classification of the issuer and/or the bond in the firm's financial statements, reducing the sample to 436 bonds issued by 179 firms.
Hybrid bond characteristics and hybrid bond market
To investigate our first hypothesis, we include three vectors 𝑅𝑒𝑝𝑜𝑟𝑡𝑖 𝑖❑ The vector 𝑅𝑒𝑝𝑜𝑟𝑡𝑖𝑛𝑔 includes several variables to capture managers' reporting incentives for issuing hybrid bonds (classified as equity). Managers of firms with higher analyst following have more incentives to issue equity-classified hybrid bonds to report coupon payments as dividends that do not affect earnings.
Managers of firms subject to more debt covenants and managers with higher portions of variable pay have greater incentives to issue hybrid equity-classified bonds to increase deal slack and compensate through higher reported performance . We include the following variables to capture firms' economic, non-reporting incentives for issuing hybrid bonds (classified as equity). Less profitable firms with higher operating and bankruptcy risk have higher incentives to issue more flexible hybrid bonds.
Companies with higher growth opportunities tend to rely more on flexible equity financing, thereby increasing incentives to issue hybrid bonds.
Empirical results
Determinants to issue corporate hybrid bonds
Companies with higher effective tax rates have incentives to issue CHBs to increase their debt tax shield and reduce tax payments. The coefficient on 𝐶𝑟𝑒𝑑𝑖𝑡 𝑅𝑎𝑡𝑖𝑛𝑔 is statistically significant at the 1% level in columns 1 and 2, indicating an economically large increase in firms' probability of issuing CHBs. When the company is covered by a credit rating agency, our OLS regression results suggest an increase of 14.60 (t-stat: 11.23) to 18.50 (t-stat: 7.71) percentage points in the probability of having CHBs to be issued instead of senior bonds.
These results support our predictions and are consistent with anecdotal evidence that credit ratings are one of the primary motivations for issuing hybrid bonds. Only the coefficient on 𝐴𝑛𝑎𝑙𝑦𝑠𝑡𝐹𝑜𝑙 is negative and statistically significant in three out of four specifications (including logit regressions). Finally, we also find that other non-reporting incentives are associated with firms' choices to issue CHBs.
Better performing firms with higher operational risk are less likely to issue CHBs, as indicated by the negative and statistical data.
Determinants of accounting classification of corporate hybrid bonds
The coefficient estimate suggests a 6.70 to 8.60 percentage point increase in the probability of issuing stock-marked CHBs for a one standard deviation increase in the share of performance-based compensation. Along these lines, the coefficient of 𝐶𝑜𝑣𝑒𝑛𝑎𝑛𝑡𝑠 is statistically significant at the 5% level and suggests an increase in the probability of issuing equity marked bonds with 2.60 percentage point increase in the number of deviation coefficients for one standard deviation. The coefficient on 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒 is positive and statistically significant in three out of four specifications, suggesting a 6.40 to 8.30 percentage point increase in the probability of issuing equity-marked CHBs (5.50 percentage points using logit).
To test our second hypothesis (H2) and measure whether investors perceive CHBs as equity- or debt-like instruments, we compare announcement effects around CHB offerings with announcement effects of senior bonds and seasoned equity issues. In addition, we estimate 𝐶𝐴𝑅𝑖,𝑡 for an announcement sample of equity offerings and senior bond offerings against which we can benchmark announcement effects of hybrid bond offerings. To compare the announcement effects of CHB issuances with the announcement effects of equity and senior bond offerings, we estimate the following regression model.
The coefficient 𝛽2 captures differences in announcement effects between debt-marked CHB offerings and senior bond offerings.
Empirical results
So if investors view debt-labeled CHBs as comparable to senior bonds, we expect 𝛽2 to be economically and statistically insignificant. So if investors do not distinguish between debt-labeled and equity-labeled CHBs, we expect 𝛽1+ 𝛽3 to be economically and statistically insignificant. Announced returns around equity- and debt-labeled CHB offerings are economically and statistically insignificant.
Announcement returns around equity-denominated CHB offerings amount to 0.02%, while announcement returns around debt-denominated CHBs amount to 0.26%. While the difference in announcement returns between senior bond offerings and debt-branded CHBs remains economically and statistically insignificant, the difference in announcement returns between seasoned equity offerings and equity-branded CHBs is statistically and economically significant. While we observe insignificant differences in announcement returns between senior bond and debt-rated CHB offerings (𝛽2 remains economically and statistically insignificant), we observe economically and statistically significant differences in announcement returns between seasoned equity and equity-rated CHBs (𝛽2+ ) statistically significant at the 1% level ).
Finally, we also do not observe an economically or statistically significant difference in advertising returns between equity-classified and debt-classified CHBs (𝛽1+ 𝛽3 remain economically and statistically insignificant).
Empirical results
If equity investors consider the contractual features and financial content of CHBs as debt instruments, then we expect the coefficient of 𝛽2 to be negative for both equity- and debt-classified CHBs. If, on the other hand, investors follow the accounting mark and value equity-classified CHBs as equity, we expect the coefficient 𝛽2 to be positive. In a next step, we adjust equation (4) to include the book value of debt-rated CHBs.
Specifically, we replace the book value of equity per share with total assets per share (𝑇𝐴𝑃𝑆) and total liabilities (net of CHBs classified as debt) (𝑇𝐿𝑃𝑆 𝑒𝑥 𝐻𝐵𝑃𝑆) per share. We then include the book value of the debt-labeled CHBs and report the results in column 4. The results suggest that equity-classified CHBs are priced as equity when accounting transparency is low (i.e., there are no separate financial statements of hybrid bonds).
The insignificant valuation coefficient may be due to disagreement among investors regarding their valuation of equity-classified CHBs or a lack of statistical power due to the smaller sample of high-transparency firms.
Effect of hybrid bond issuances on analysts’ forecast accuracy
The valuation coefficient on 𝐵𝑉𝐸𝑃𝑆 (𝑒𝑥 𝐻𝐵𝑃𝑆) is positive and statistically significant at the 1% level in columns 1 and 2. Panel A of Table 6 reports the results for equity (classified as debt) in the even (odd) numbered columns. The coefficient on 𝑃𝑜𝑠𝑡 is positive and statistically significant at the 5% level in all three specifications, indicating that the error and dispersion of analysts' forecasts increase after the issuance of equity-classified CHBs.
For firms issuing debt-classified CHBs, the coefficient on 𝑃𝑜𝑠𝑡 remains statistically insignificant in all three specifications. The difference in Next, we analyze whether the decrease in forecast accuracy is concentrated in firms that provide low transparency in their equity-labeled CHBs.
Our results in Panel B of Table 6 suggest that the decline in forecast accuracy is concentrated in firms that do not separate the book value of CHBs (coupon payments) from the book value of equity (earnings).
Investor reactions to proposed reclassification of hybrid bonds
Our findings suggest that equity investors see the potential reclassification of hybrid bonds as costly. This table reports the initial sample selection steps for our sample of hybrid bonds in Panel A. Panel C provides an overview of the distribution of the number of issues and the volume of hybrid bonds issued by year, industry, and country in our sample.
Panel C reports descriptive statistics for the sample used to estimate regression model (5) to analyze the significance of the book values of hybrid bonds. The approach of the time feature in relation to the amount feature was first mentioned in a working paper by the IASB. In this paper, the preferred approach consisting of time feature and amount feature was formally proposed by IASB.
The IASB decides on an approach that explains the fundamental principles of the current IAS 32. TR Refinitiv Covenants Defined as the natural logarithm of the annual number of debts of the company. The issuer's obligations from debt securities represent the issuer's unsecured obligations, which in the event of insolvency or liquidation of the issuer are classified as a.
ONLINE APPENDIX B
To test the effects of announcements around senior bond, hybrid bond, and seasoned equity offering announcements, in a first step we collect senior bond, hybrid bond, and seasoned equity offering announcements from firms that also issue hybrid bonds. We then remove observations with missing values for CAR, resulting in 328 hybrid bond announcements, 1,304 senior bond announcements, and 646 seasoned stock announcements. In a final step, we remove observations with missing values for control variables, resulting in 312 hybrid bond announcements, 1,240 senior bond announcements, and 622 seasoned equity announcements from 174 sample firms.
To test the value relevance of the book values of hybrid bonds, in a first step we manually collect financial statement data on hybrid bonds. For 175 of our 179 sample firms, we were able to verify and hand-collect the book values of the hybrid bonds, resulting in a total of 950 firm-year observations. This table reports summary statistics of companies issuing hybrid bonds classified as equity or debt, and the mean differences in the sample.
In columns (3) and (4), we report results for the determinants of firms' decision to issue hybrid bonds classified as equity or debt under IAS 32.
