Hostname: page-component-78c5997874-xbtfd Total loading time: 0 Render date: 2024-11-15T07:50:50.119Z Has data issue: false hasContentIssue false
  • English
  • Français

Informative Conversion Ratios: A Signalling Approach

Published online by Cambridge University Press:  06 April 2009

Yong O. Kim
Get access Rights & Permissions [Opens in a new window]

Abstract

The paper uses a signalling equilibrium to explain the market's reaction to the announcement of a firm's financing decision. In our model, a firm can issue one of the following securities: convertible debt with a different conversion ratio, straight debt, and stock. We identify conditions under which the conversion ratio of a convertible debt issue serves as a credible signal of a firm's private information, given the continuous distribution of attributes (information) across firms. In this signalling equilibrium, we find that the lower the expected future earnings, the higher the conversion ratio of a convertible debt issue. At the limit, firms that expect the highest earnings will use straight debt financing, and firms that expect the lowest earnings will use equity financing. Based on the signalling equilibrium, we predict that at announcement of a convertible debt issue, negative abnormal common stock return increases in absolute value with the conversion ratio.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 25 , Issue 2 , June 1990 , pp. 229 - 243
Copyright
Copyright © School of Business Administration, University of Washington 1990

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Asquith, P., and Mullins, D. W.. “Equity Issues and Offerings.” Journal of Financial Economics, 15 (01/02 1986), 61–90.CrossRefGoogle Scholar
Constantinides, G. M., and Grundy, B.. “Optimal Investment with Stock Repurchase and Financing as Signals.” Working Paper, Graduate School of Business, Univ. of Chicago (1986).Google Scholar
Dann, L. Y., and Mikkelson, W. H.. “Convertible Debt Issuance, Capital Structure Change and Financing-Related Information: Some New Evidence.” Journal of Financial Economics, 13 (06 1984), 157–186.CrossRefGoogle Scholar
Green, R. C. “Investment Incentives, Debt and Warrants.” Journal of Financial Economics, 13 (03 1984), 115–136.CrossRefGoogle Scholar
Harris, M., and Raviv, A.. “A Sequential Signalling Model of Convertible Debt Call Policy.” Journal of Finance, 40 (12 1985), 1263–1281.CrossRefGoogle Scholar
John, K., and Williams, J. T.. “Dividends, Dilution, and Taxes: A Signalling Equilibrium.” Journal of Finance, 40 (09 1985), 1053–1070.CrossRefGoogle Scholar
Kallberg, J., and Kim, Y. O.. “Convertible Calls and Corporate Taxes under Asymmetric Information.’ Unpubl. Working Paper, Rutgers Univ., Graduate School of Management (1988).Google Scholar
Korwar, A. N., and Masulis, R.. “Seasoned Equity Offerings: An Empirical Investigation.” Journal of Financial Economics, 15 (01/02 1986), 91–118.Google Scholar
Leland, H., and Pyle, D.. “Information Asymmetries, Financial Structure and Financial Intermediation.” Journal of Finance, 32 (05 1977), 371–387.CrossRefGoogle Scholar
Mikkelson, W. H. “Convertible Calls and Security Returns.” Journal of Financial Economics, 9 (09 1981), 237–264.CrossRefGoogle Scholar
Mishra, B., and Narayanan, M. P.. “Why Do Firms Issue Callable Convertibles?” Unpubl. Working Paper, Univ. of Florida (1987).Google Scholar
Myers, S. D., and Majluf, N. J.. “Corporate Financing and Investment Decisions when Firms Have Information That Investors Do Not Have.” Journal of Financial Economics, 13 (06 1984), 187–221.CrossRefGoogle Scholar
Riley, J. G. “Informational Equilibrium.” Econometrica, 47 (03 1979), 331–359.CrossRefGoogle Scholar
Spence, A. M. “Job Market Signalling.” Quarterly Journal of Economics, 87 (08 1973), 355–379.CrossRefGoogle Scholar