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Improving the Prevention of Environmental Risks with Convertible Bonds

  • André SCHMITT
  • Sandrine SPAETER
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    In this paper, a manager borrows external funds in order to invest in production and also in prevention. The latter action must reduce the environmental risk driven by the activity of the firm. Prevention is observable neither by outside lenders nor by institutions such as environmental agencies for instance. In such a situation, we show that issuing convertible bonds - which permits the holder to exchange his bonds for a predetermined number of shares of the firm - from a limited liability firm could be a way to improve prevention compared to what can usually be done with standard debt. Such a relationship between the firm and the bank might be an alternative, or a complement, to the CERCLA legislation about extended liability which prevails in the United States and which is often discussed in Europe as a possible support of a more tightened European environmental legislation. We obtain an optimal convertible bond contract that induces more prevention and higher expected net revenues for the firm than standard debt. The expected social welfare is also improved. Finally, the economic implications of our findings are discussed.

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    Paper provided by Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg in its series Working Papers of BETA with number 2002-14.

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    Date of creation: 2002
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    Handle: RePEc:ulp:sbbeta:2002-14
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    5. Boyer, M. & Laffont, J.J., 1995. "Environmental Risks and Bank Liability," Cahiers de recherche 9501, Universite de Montreal, Departement de sciences economiques.
    6. Posey, Lisa Lipowski, 1993. "Limited liability and incentives when firms can inflict damages greater than net worth," International Review of Law and Economics, Elsevier, vol. 13(3), pages 325-330, September.
    7. GOBERT, Karine & POITEVIN, Michel, 1998. "Environmental Risk: Should Banks Be Liable?," Cahiers de recherche 9808, Universite de Montreal, Departement de sciences economiques.
    8. Marco LiCalzi & Sandrine Spaeter, 2003. "Distributions for the first-order approach to principal-agent problems," Economic Theory, Springer, vol. 21(1), pages 167-173, 01.
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    12. Bascha, Andreas & Walz, Uwe, 2001. "Convertible securities and optimal exit decisions in venture capital finance," Journal of Corporate Finance, Elsevier, vol. 7(3), pages 285-306, September.
    13. Jeremy C. Stein, 1992. "Convertible Bonds as "Back Door" Equity Financing," NBER Working Papers 4028, National Bureau of Economic Research, Inc.
    14. Sappington, David, 1983. "Limited liability contracts between principal and agent," Journal of Economic Theory, Elsevier, vol. 29(1), pages 1-21, February.
    15. Coestier, B., 2000. "Dynamic Financial Contract under Extended Liability," Ecole des Hautes Etudes Commerciales de Montreal- 00-08, Ecole des Hautes Etudes Commerciales de Montreal-Chaire de gestion des risques..
    16. Dionne, Georges & Viala, Pascale, 1994. "Moral hazard, renegotiation and debt," Economics Letters, Elsevier, vol. 46(2), pages 113-119, October.
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    18. Barnea, Amir & Haugen, Robert A & Senbet, Lemma W, 1980. " A Rationale for Debt Maturity Structure and Call Provisions in the Agency Theoretic Framework," Journal of Finance, American Finance Association, vol. 35(5), pages 1223-34, December.
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