Improving the prevention of environmental risks with convertible bonds

Andre Schmitt and Sandrine Spaeter ()
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Andre Schmitt: LARGE - Laboratoire de recherche en gestion et économie - Université Louis Pasteur - Strasbourg I - Université Robert Schuman - Strasbourg III
Sandrine Spaeter: BETA - Bureau d'Économie Théorique et Appliquée - INRA - Institut National de la Recherche Agronomique - UNISTRA - Université de Strasbourg - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique

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Abstract: This paper considers a limited liability firm that needs external funds in order to invest in an activity that presents an environmental risk for the Society. When the firm's risk-reducing activities cannot be observed by the lenders, we show that the issue of convertible bonds can create incentives to improve prevention. Convertible bonds allow the holder to exchange his bonds for a fixed number of the firm's shares. The use of such hybrid securities could either complement or be an alternative to the American CERCLA legislation about lender extended liability. We define an optimal convertible bond contract that induces unchanged economic profits for the bank, more prevention and higher expected net revenues for the firm and a higher expected social welfare than with standard debt. Our results hold true both with and without extended liability.

Keywords: Moral hazard; Environmental risk; Limited liability; Prevention; Convertible bond (search for similar items in EconPapers)
Date: 2006
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Published in Journal of Environmental Economics and Management, 2006, 50 (3), pp.637-657. ⟨10.1016/j.jeem.2005.05.003⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00279138

DOI: 10.1016/j.jeem.2005.05.003

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