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Capital structure pre-balancing: Evidence from convertible bonds

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  • Rastad, Mahdi

Abstract

A large body of the corporate finance literature is devoted to capital structure. This literature examines whether firms have a target capital structure, and whether they actively rebalance their capital structure toward a target. Since conversion of a convertible bond causes a drop in leverage, target capital structure theory suggests that the structure should be rebalanced in the future. I consistently find that following a realized conversion firms rebalance their positions in less than a year. When the stock price passes the conversion price threshold for a convertible bond, the firm expects this drop in leverage to occur in the near future. Using a regression discontinuity design around the conversion price threshold for those conversions that are decided by investors, not by the firm, my paper documents a 20% increase in leverage before an actual drop in leverage. That is to say, firms do not wait for the realization of leverage shocks but rather respond to anticipated shocks. A quantile treatment effect analysis reveals the effect to be a hump-shaped function of leverage, with a peak for firms with a conditional leverage ratio around the 70th percentile.

Suggested Citation

  • Rastad, Mahdi, 2016. "Capital structure pre-balancing: Evidence from convertible bonds," Journal of Corporate Finance, Elsevier, vol. 41(C), pages 43-65.
    • Handle: RePEc:eee:corfin:v:41:y:2016:i:c:p:43-65
    DOI: 10.1016/j.jcorpfin.2016.08.015
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    Cited by:

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    More about this item

    Keywords

    Financing policy; Capital structure; Trade-off theory; Convertible bonds; Regression discontinuity;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models

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