Economics at your fingertips  

A theory of mandatory convertibles

Thomas Chemmanur, Debarshi Nandy, An Yan and Jie Jiao

Journal of Banking & Finance, 2014, vol. 42, issue C, 352-370

Abstract: The objective of this paper is to develop a theoretical analysis of “mandatory convertibles,” which are securities that automatically (“mandatorily”) convert to common stock on a pre-specified date. We consider a firm facing a financial market characterized by asymmetric information and significant costs in the event of financial distress. The firm can raise capital either by issuing mandatory convertibles, or by issuing more conventional securities like straight debt, ordinary convertibles, or equity. We show that, in equilibrium, the firm issues straight debt or ordinary convertibles if the extent of asymmetric information facing it is large, but the probability of being in financial distress is relatively small; it issues mandatory convertibles if it faces a smaller extent of asymmetric information but a greater probability of financial distress. Our model provides a rationale for the three commonly observed features of mandatory convertibles: mandatory conversion, capped (or limited) capital appreciation, and a higher dividend yield compared to common stock. We also characterize the equilibrium design of mandatory convertibles.

Keywords: Asymmetric information; Mandatory convertibles; Ordinary convertibles (search for similar items in EconPapers)
JEL-codes: G24 G32 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3) Track citations by RSS feed

Downloads: (external link)
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

DOI: 10.1016/j.jbankfin.2014.01.024

Access Statistics for this article

Journal of Banking & Finance is currently edited by Ike Mathur

More articles in Journal of Banking & Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().

Page updated 2023-05-18
Handle: RePEc:eee:jbfina:v:42:y:2014:i:c:p:352-370