Financing Innovations And Capital Structure Choices

The last two decades have seen a stream of innovation in financial markets, especially in corporate bonds. Some of these innovations—notably, hybrid debt—have provided firms with more flexibility in designing cash flows on borrowings, allowing them to match cash flows on financing more closely to cash flows on assets. In so doing, the use of such innovative securities has increased corporate debt capacity and hence firm value. But if such changes have been mostly good news for corporate treasurers, the relentless torrent of innovation has sometimes resulted in firms issuing these new securities for the wrong reasons. Some have done so to take advantage of loopholes in the way ratings agencies and regulatory agencies define debt and equity—and others to exploit perceived pricing anomalies—without considering the effect of such securities on the firm's overall risk profile. In this context, it is worth noting that as corporate bonds have become more complex, investment bankers have made themselves indispensable to the process by providing pricing as well as selling support. This article aims to help managers distinguish when financing with complex securities serves their company's interests, and when it can end up hurting them.