Mandatory Convertible Bonds and the Agency Problem

Angel Huerga and Carlos Rodríguez-Monroy
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Angel Huerga: Department of Organization Engineering, Business Administration and Statistics, Industrial Engineering School, Universidad Politécnica de Madrid (UPM), 28006 Madrid, Spain
Carlos Rodríguez-Monroy: Department of Organization Engineering, Business Administration and Statistics, Industrial Engineering School, Universidad Politécnica de Madrid (UPM), 28006 Madrid, Spain

Sustainability, 2019, vol. 11, issue 15, 1-21

Abstract: A large proportion of the academic literature about the agency problem focuses on corporate governance or the instruments that can be used to balance the incentives of shareholders and debt holders. Following the real options company valuation framework, one method to increase shareholder value involves increasing the intrinsic risk of the firm; however, such a practice reduces the bondholder value. We analyzed an innovative balance sheet instrument, the mandatory convertible bond, as a means to increase financial sustainability of companies, improving the value for shareholders without increasing the perceived default risk. The results of the empirical analysis illustrate that for companies in a weak credit position, the agency problem can be mitigated by the issuance of mandatory convertible bonds, which allows managers to increase company risk without being detrimental for bondholders. However, when the probability of distress is small, shareholders have less incentive to increase company risk than in a company funded by mandatory convertible bonds, being more aligned with bondholders. A better alignment of debt holders and shareholders incentives reduces inefficiencies, mitigates the probably of distress, and improves the long-term financial sustainability of companies and can promote stable growth and innovation.

Keywords: mandatory convertible bonds; agency problem; sustainable finance; volatility; real options (search for similar items in EconPapers)
JEL-codes: O13 Q Q0 Q2 Q3 Q5 Q56 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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