Innovation in Euromarket hybrid funding instruments

Andrew P. Marshall

European Financial Management, 1995, vol. 1, issue 3, 331-340

Abstract: This paper considers case studies of the use of innovative hybrid funding instruments—which have features of debt and equity issued by UK companies in the Euromarket. It considers why these instruments were developed and how they utilise the ‘grey areas' in accounting and tax regulations to achieve what managers perceive to be the main benefits of each. One of the major influences on the choice of funding instruments for a number of companies involved in acquisitions in the late 1980s was their accounting and tax treatment. the search was for cost effective finance which at the same time contributed a premium to blunt the purchased goodwill write‐off. Group reserves have no legal significance but goodwill write‐offs can have consequences for a group constrained by borrowing restrictions (based on its balance sheet figures). the concern with the shape of the balance sheet and the ratios calculated using these figures, combined with perceived beliefs about the tax advantages of borrowing led to the development of the Euroconvertible Preference Share issues by subsidiary companies in 1989. the tax authorities removed the attraction of this instrument to issuers. However, the innovative process continued and similar accounting and tax explanations influenced the design of another major category of hybrid—the Convertible Capital Bond. Accounting regulators have reacted to this hybrid by producing new guidelines which have removed its benefits and therefore its attraction to companies. Nonetheless, the process of innovation continues and a new instrument—the Irredeemable Convertible Bond—has been developed.

Date: 1995
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