Securities That Do the Deal: the Decision to Issue Convertible Preference Shares by Uk Firms

This paper uses in-depth interviews with Finance Directors from UK firms that have recently issued convertible preference shares. The study examines the particular circumstances that were taken into account into the decision to issue convertible preference shares rather than the more common instruments of pure debt or pure equity. The paper relates the findings from the interviews to three theories that have been suggested for the issuance of preference shares. These theories are Pecking Order, Taxation and Financial Distress. Pecking Order is a general capital structure theory and the Taxation and Financial Distress theories have been developed from the general static trade off theory for capital structure. This paper examines whether “local” decision making for specific instruments can be related to global generalisations for capital structure theories. The comments from the interviews suggest that global capital structure theories for the use of pure debt and pure equity are not a major factor in the decision to issue convertible preference shares. Comments from the interviews suggest that the Finance Directors regard financial planning principles to be of more importance in the decision making process than capital structure principles. These considerations include future cash flows and the nature of the risk of the asset the funding is to be provided for. However, the interviews provide deeper insights into the decision making process in that in each case the decision to issue convertible preference shares was an outcome of a “financial engineering” process. In all but one of the cases there was a close relationship between the issuers and investors and the needs of the investors was a major factor in determining the type of instrument to be issued. The investors exercised a level of control so that the type of instrument being issued was not one that the issuers felt comfortable with and would not, in other circumstances, have issued convertible preference shares. Convertible preference shares were issued as a necessity to “do the deal”, even though they were felt, by the issuer, to have a number of disadvantages.