Capital Structure Decision: The Use Of Preference Shares And Convertible Debt In The UK

Abstract

This aim of this study is to test whether existing capital structure theories relating to the use of straight debt and equity explain the use, in the UK, of preference shares as equity securities and convertible debt as debt securities. The study provides an empirical examination of the influence of non-debt tax shield, size, volatility of earnings, growth, asset structure and profitability. A second aim of the study is to examine to what extent firms in the UK may be using preference shares for their debt attributes and convertible debt for their equity attributes. The sample comprises 331 firms for the period 1992 ? 1997. The sample includes firms who use preference shares and convertible debt as well as a similar number of firms who do not use these instruments. Evidence obtained so far provides strong support for the suggestion that tax shields on debt play a minor, rather than major role, in the financing decision as the use of preference shares were found to have significant negative relationships with non-debt tax shields. Asset structure is also found to have an unexpected relationship with preference shares. These findings support the idea that firms may consider the agency, characteristics of preference shares as being more advantageous, when looking at what type of security to issue. Firms use less risky securities, other than straight equity, in order to reduce the agency conflicts of debt. Convertible debt is also found to have a counter-intuitive relationship with non-debt tax shields. Further evidence for convertible debt supports a recent study by Munro (1996) that convertible debt issuers tended to be large and intangible intensive. The evidence obtained for both preference shares and convertible debt does not rationalise the use of these instruments according to traditional capital structure theories. The study provides scope for further research to support the idea that firms use these hybrid securities for reasons other than those explored by traditional capital structure theories. Key words: Capital Structure Theories Preference Shares Convertible Debt