Convertible Debt and Shareholder Incentives

Christian Dorion, Pascal François, Gunnar Grass and Alexandre Jeanneret

Cahiers de recherche from CIRPEE

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.

Keywords: Convertible bonds; Risk-shifting; Asset substitution; Agency conflict; Financial distress; Asset volatility; Contingent claims (search for similar items in EconPapers)
JEL-codes: G12 G32 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:lvl:lacicr:1403

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