In search of a free lunch: hybrid financial securities in Australia

Since the turn of the new millennium, much attention has been focused on the pressing problem of improving corporate governance. A key element of this global trend has been an increased focus on transparency and quality in financial reporting. Yet at the same time as the spotlight has been shone brightly on the quality and transparency of financial reporting, the use of hybrid debt equity securities has undergone a renaissance in Australia. For issuers, these securities typically combine the dual attractions of high tax effectiveness and low cost of funds, while investors have exhibited strong demand for these securities because of the enhanced yields they typically offer in comparison to ordinary equity securities. From a financial reporting perspective however, these instruments can present a range of threats to transparency, consistency and comparability. This paper reports on a study of a sample of hybrid securities issued by large Australian listed corporations between 2002 and 2004. The paper focuses on the key financial reporting impacts of this sample. From a balance sheet perspective these include the frequency with which the securities were classified as equity and the resulting impact on leverage ratios and other traditional risk measures. The impact of these securities on reported earnings and key financial performance metrics is also discussed. Policy implications are drawn from the findings by way of conclusion.