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Adverse Selection and Convertible Bonds


  • Archishman Chakraborty
  • Bilge Yilmaz


Informational asymmetries between a firm and investors may lead to adverse selection in capital markets. This paper demonstrates that when the market obtains noisy information about a firm over time, this adverse selection problem can be costlessly solved by issuing callable convertible bonds with restrictive call provisions. Such securities can be designed to make the payoff to new claimholders independent of the private information of the manager. This eliminates the possibility of any dilution of equity or underinvestment and implements the symmetric information outcome in either a pooling or a separating equilibrium. The same first-best efficient outcome can also be implemented by issuing floating-price and mandatory convertibles. Copyright 2011, Oxford University Press.

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  • Archishman Chakraborty & Bilge Yilmaz, 2011. "Adverse Selection and Convertible Bonds," Review of Economic Studies, Oxford University Press, vol. 78(1), pages 148-175.
  • Handle: RePEc:oup:restud:v:78:y:2011:i:1:p:148-175

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    Cited by:

    1. Elettra Agliardi & Rossella Agliardi & Willem Spanjers, 2015. "Convertible Debt: Financing Decisions and Voluntary Conversion under Ambiguity," International Review of Finance, International Review of Finance Ltd., vol. 15(4), pages 599-611, December.
    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. Mike Burkart & Samuel Lee, 2010. "Signaling in Tender Offer Games," FMG Discussion Papers dp655, Financial Markets Group.
    4. Qiu, Junfeng & Zhang, Yongli, 2013. "Convertible bonds with resettable conversion prices," Economic Modelling, Elsevier, vol. 31(C), pages 198-205.
    5. Cerezo Sánchez, David, 2017. "An Optimal ICO Mechanism," MPRA Paper 81285, University Library of Munich, Germany.

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