Capital structure pre-balancing: Evidence from convertible bonds

Mahdi Rastad

Journal of Corporate Finance, 2016, vol. 41, issue C, 43-65

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.

Keywords: Financing policy; Capital structure; Trade-off theory; Convertible bonds; Regression discontinuity (search for similar items in EconPapers)
JEL-codes: C31 G32 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:41:y:2016:i:c:p:43-65

DOI: 10.1016/j.jcorpfin.2016.08.015

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