Hybrid Financial Instruments, Cost of Capital and Regulatory Arbitrage - an Empirical Investigation

Data recently published by the Reserve Bank of Australia clearly demonstrates that after a period in abeyance, hybrid financial instruments have again become popular tools for capital raising and management. This raises several questions of practical and theoretical significance, particularly in relation to the motivation for adopting hybrid instruments as an element of firm capital structure, and the impact of putting this choice into effect. In this paper, we examine two key themes. First, we analyse the extent to which the rise of hybrid instruments can be justified on the grounds that the use of these instruments can result in lower firm cost of capital. We also investigate the impact on firm financial reports and key metrics of financial performance of risk which result from the deployment of hybrid financial instruments as components of firm capital structure. We conclude by expressing scepticism as to the proposition that the use of hybrid instruments systematically lowers issuer cost of capital, and argue that the use of hybrid instruments has caused material distortions to emerge within the financial statements of firms which employ them