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Convertible Debt and Shareholder Incentives

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  • Christian Dorion
  • Pascal François
  • Gunnar Grass
  • Alexandre Jeanneret
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    Abstract

    Given equity’s convex payoff function, shareholders can transfer wealth from bondholders by increasing firm risk. We test the existing hypothesis that convertible debt reduces this classical agency problem of risk-shifting. First, we derive a measure of shareholders’ risk incentives induced by convertible debt using a contingent claims framework. We then document that when risk-shifting incentives are high, the propensity to issue convertible (rather than straight) debt increases and the negative stock market reaction following convertible debt issue announcements is amplified. We further highlight that convertible debt is the only type of security that affects business risk durably downwards. Our conclusions support the agency theoretic rationale for convertible debt financing especially for financially distressed firms.

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    Bibliographic Info

    Paper provided by CIRPEE in its series Cahiers de recherche with number 1403.

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    Date of creation: 2014
    Date of revision:
    Handle: RePEc:lvl:lacicr:1403

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    Related research

    Keywords: Convertible bonds; Risk-shifting; Asset substitution; Agency conflict; Financial distress; Asset volatility; Contingent claims;

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    References

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    Cited by:
    1. Henderson, Brian J. & Zhao, Bo, 2014. "More than meets the eye: Convertible bond issuers' concurrent transactions," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 57-79.
    2. Dutordoir, Marie & Lewis, Craig & Seward, James & Veld, Chris, 2014. "What we do and do not know about convertible bond financing," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 3-20.
    3. Dutordoir, Marie & Strong, Norman & Ziegan, Marius C., 2014. "Does corporate governance influence convertible bond issuance?," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 80-100.
    4. Lewis, Craig M. & Veld, Chris, 2014. "Convertible bond financing," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 1-2.
    5. Lyandres, Evgeny & Zhdanov, Alexei, 2014. "Convertible debt and investment timing," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 21-37.

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