Financial Markets
In their seminal 1989 work, Kopcke and Rosengren posed the question "are the distinctions between debt and equity disappearing?" They noted several challenges to the historical distinction between the two, including new instruments that combined elements of each (e.g. preferred shares, warrants, mezzanine financing) and an increased use in derivative securities. They noted that debt instruments were beginning to incorporate equity-like features, in response to market demand for such innovative forms of financing. The authors also note that in the U.S. At least the tax code and regulatory environment was not keeping up with the changes, contributing to the proliferation of hybrid securities. On closer examination, however, none of these changes indicates a fundamental change in the nature of debt or the nature of equity, simply a change in market preferences. Hybrids have not eliminated or even materially altered debt or equity, they have simply offered the market alternatives.
Damodar (n.d.) notes that there has always been a continuum between debt and equity. While the two are clearly different at the ends of the continuum (common stock and bonds), securities that lie in the middle of the continuum have always contained elements of each. Preferred shares and convertible bonds, for example, have been around for decades. The basic differences between equity and debt are outlined as follows. If the payments from the security are contractual, this is closer to debt and if payments are residual this is closer to equity. Tax treatment is another way to differentiate, except as Kopcke and Rosengren (1989) note where the tax code has not kept up with market innovations and may therefore not be an accurate reflector of whether a security is debt or equity. However, by Damodar's theory, securities that lie along the continuum rather than at its ends will always be subject to such questions -- attempts to classify such securities as either debt or equity will inherently fail due to the application of false dichotomy to the question.
Even if there is a rise in the usage of hybrid financing instruments, this does not imply widespread blurring of the distinction between debt and equity. For one, Kopcke and Rosengren framed their discussion vs. The most traditional capital structure forms, which dominated business for the mid-part of the 20th century. Framing modern capital structure practices vs. ones that just happened to be exceptionally rigid says little. One must instead consider whether the traditional debt and equity distinctions have genuinely been eroded, and that is not the case. Common stock and conventional debt instruments remain the norm in capital markets, despite increased use of hybrid instruments. The market for hybrid instruments requires higher knowledge on the part of investors, so is inherently less liquid than the market for conventional instruments. This limits the use of hybrids; even academics who study capital structure have little trouble making a clear distinction between debt and equity on corporate balance sheets (Phillips & Sipahoglu, 2004; Myers, 2005).
While the topic is worthy of discussion, there is little evidence to support the contention that any change has occurred in the nature of debt or the nature of equity to declare that any line has blurred between the two. Hybrid instruments are just that -- instruments born of the combination of traits that derive from two distinct entities. It is easy to break down a hybrid instrument into its constituent debt and equity-derived components on the basis of Damodar's criteria. Conflating the rise of hybrid instruments with erosion in the definition of traditional debt and traditional equity is a logical fallacy. As traditional debt and traditional equity are alive in their pure forms, and remain the most popular forms of financing for public companies, the hypothesis that there has been erosion in their definition is demonstrably false. The question would be better framed as an issue of usage, such a question about the role of hybrid instruments in the optimal capital structure than arguing about whether two forms of capital that remain dominant in the market and unchanged no longer exist.
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Valuing assets that are not publicly-traded can be challenging. The UK government has come under fire for what is perceived to be undervaluing of assets that were privatised, for example British Gas, British Telecom, British Airlines, and more. There remain many assets that could be sold off in the future such as Channel 4, the Royal Bank of Scotland, the Royal Mint and BBC Worldwide, raising the issue of appropriate valuation and value for money for the British taxpayer (Hawkins, 2010). Oxlade (2011) notes that British Gas shares have increased...
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