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Signaling with Convertible Debt

Author

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  • Davidson, Wallace N.
  • Glascock, John L.
  • Schwarz, Thomas V.

Abstract

We test whether the conversion price (ratio) is viewed by the stock market as a credible signal of the firm's future earnings prospects (Kim (1990)) and, subsequently, whether convertible debt serves as backdoor equity financing (Stein (1992)). Examining the conversion price in relation to current stock prices and a priori growth expectations produces an average expected time of less than 1.5 years for convertible bonds to be at-the-money. Thus, as Stein suggests, convertibles appear to be a method of drawing equity into a firm's capital structure. We also find that the size of the firm's announcement period abnormal returns is positively related to the expected time for the convertible to become at-the-money. Given these relationships, we conclude that convertible debt issue announcements, on average, send an equity-like signal to the market.

Suggested Citation

  • Davidson, Wallace N. & Glascock, John L. & Schwarz, Thomas V., 1995. "Signaling with Convertible Debt," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(3), pages 425-440, September.
    • Handle: RePEc:cup:jfinqa:v:30:y:1995:i:03:p:425-440_00
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    Cited by:

    1. Roland Gillet & Hubert De La Bruslerie, 2010. "The Consequences of Issuing Convertible Bonds: Dilution and/or Financial Restructuring?," European Financial Management, European Financial Management Association, vol. 16(4), pages 552-584, September.
    2. Jorge Vieira da Costa Jr & Alfredo Sarlo Neto & Andrea Bispo da Silva, 2016. "Balance sheet classification of compound financial instruments and the judgment of securities market analysts," Journal of Economic and Financial Studies (JEFS), LAR Center Press, vol. 4(5), pages 37-54, October.
    3. Masaki Mori & Joseph Ooi & Woei Wong, 2014. "Do Investor Demand and Market Timing Affect Convertible Debt Issuance Decisions by REITs?," The Journal of Real Estate Finance and Economics, Springer, vol. 49(4), pages 524-550, November.
    4. Manuel Ammann & Kristian Blickle & Christian Ehmann, 2017. "Announcement Effects of Contingent Convertible Securities: Evidence from the Global Banking Industry," European Financial Management, European Financial Management Association, vol. 23(1), pages 127-152, January.
    5. Sze Kim Chin & Nur Adiana Hiau Abdullah, 2013. "Announcements Effect of Corporate Bond Issuance and Its Determinants," Contemporary Economics, University of Economics and Human Sciences in Warsaw., vol. 7(1), March.
    6. Li, Xiaoyang & Lin, Shannon & Tucker, Alan L., 2016. "The curious case of converts," Global Finance Journal, Elsevier, vol. 31(C), pages 1-17.
    7. Sri Noor Aishah Binti Mohd Salleh & Karren Lee-Hwei Khaw, 2018. "Frequency and Sequence: Convertible Debt Issuance Announcement Effect on Stock Returns," Capital Markets Review, Malaysian Finance Association, vol. 26(2), pages 1-20.
    8. Magennis, Darren & Watts, Edward & Wright, Sue, 1998. "Convertible notes: the debt versus equity classification problem," Journal of Multinational Financial Management, Elsevier, vol. 8(2-3), pages 303-315, September.
    9. 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.
    10. Burlacu, Radu, 2000. "New evidence on the pecking order hypothesis: the case of French convertible bonds," Journal of Multinational Financial Management, Elsevier, vol. 10(3-4), pages 439-459, December.
    11. Marie Dutordoir & Patrick Verwijmeren, 2008. "Why do Convertible Issuers simultaneously Repurchase Stock? An Arbitrage-based Explanation," Working Papers 0802, Departament Empresa, Universitat Autònoma de Barcelona, revised Feb 2008.
    12. Dutordoir, M.D.R.P. & Van de Gucht, L., 2006. "Are There Windows of Opportunity for Convertible Debt Issuance? Evidence for Western Europe," ERIM Report Series Research in Management ERS-2006-055-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    13. Ammann, Manuel & Fehr, Martin & Seiz, Ralf, 2006. "New evidence on the announcement effect of convertible and exchangeable bonds," Journal of Multinational Financial Management, Elsevier, vol. 16(1), pages 43-63, February.
    14. Jung, Mookwon & Sullivan, Michael J., 2009. "The signaling effects associated with convertible debt design," Journal of Business Research, Elsevier, vol. 62(12), pages 1358-1363, December.
    15. de Jong, Abe & Dutordoir, Marie & Verwijmeren, Patrick, 2011. "Why do convertible issuers simultaneously repurchase stock? An arbitrage-based explanation," Journal of Financial Economics, Elsevier, vol. 100(1), pages 113-129, April.
    16. Chang, Shao-Chi & Chen, Sheng-Syan & Liu, Yichen, 2004. "Why firms use convertibles: A further test of the sequential-financing hypothesis," Journal of Banking & Finance, Elsevier, vol. 28(5), pages 1163-1183, May.
    17. Florence Andre-Le Pogamp & Khalid El Badraoui, 2013. "Security Design of Callable Convertible Bonds and Issuers' External Financing Costs," Brussels Economic Review, ULB -- Universite Libre de Bruxelles, vol. 56(1), pages 61-81.
    18. 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.
    19. Aron A. Gottesman, 2004. "The Strategic use of Convertible Debt in “Deep Pocket†Predatory Games," The American Economist, Sage Publications, vol. 48(1), pages 50-60, March.
    20. Lee, Cheng-Few & Lee, Kin-Wai & Yeo, Gillian Hian-Heng, 2009. "Investor protection and convertible debt design," Journal of Banking & Finance, Elsevier, vol. 33(6), pages 985-995, June.
    21. Arnold R. Cowan, 1996. "Convertible Exchangeable Preferred Stock," Finance 9606001, University Library of Munich, Germany, revised 12 Aug 1996.
    22. Dong, Ming & Dutordoir, Marie & Veld, Chris, 2019. "How can we improve inferences from surveys? A new look at the convertible debt questions from the Graham and Harvey survey data," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 61(C), pages 213-222.
    23. Dutordoir, Marie & Van de Gucht, Linda, 2007. "Are there windows of opportunity for convertible debt issuance? Evidence for Western Europe," Journal of Banking & Finance, Elsevier, vol. 31(9), pages 2828-2846, September.
    24. Orlova, Svetlana & Harper, Joel T. & Sun, Li, 2020. "Determinants of capital structure complexity," Journal of Economics and Business, Elsevier, vol. 110(C).

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