Competing Debt-Equity Classification Regimes: Do Firms Care More About Accounting Standards or Rating Agencies?

Abstract

Our study examines firms’ motivation to issue hybrid securities and whether firms care more about their classification under accounting standards or their treatment by rating agencies. We focus on hybrid bonds, which became the most relevant hybrid security for European non-financial firms. Depending on the chosen structure, hybrid bonds will (i) decrease GAAP leverage or/and (ii) support firm’s credit rating. Our findings document that firms issue hybrid bonds in quarters when their incentive to manage credit ratings increases. Conversely, changes in GAAP leverage ratios do not seem to impact firm’s decision to issue a hybrid bond. When comparing the types of hybrid bonds issued across rated and unrated firms, our findings reveal that rated firms more often choose to issue hybrid bonds that are classified as debt under accounting standards. These findings suggests that European rated firms care more about the treatment of a hybrid security by rating agencies than about its classification under accounting standards.