Hostname: page-component-78c5997874-xbtfd Total loading time: 0 Render date: 2024-11-15T08:00:28.915Z Has data issue: false hasContentIssue false
  • English
  • Français

Signaling with Convertible Debt

Published online by Cambridge University Press:  06 April 2009

Wallace N. Davidson III ,
John L. Glascock  and
Thomas V. Schwarz
Wallace N. Davidson III
Affiliation:
Department of Finance, Southern Illinois University, Carbondale, IL 62901
John L. Glascock
Affiliation:
Department of Finance, Louisiana State University, Baton Rouge, LA 71270.
Thomas V. Schwarz
Affiliation:
Department of Finance, Southern Illinois University, Carbondale, IL 62901
Get access Rights & Permissions [Opens in a new window]

Abstract

We test whether the conversion price (ratio) is viewed by the stock market as a credible signal of the firm's future earnings prospects (Kim (1990)) and, subsequently, whether convertible debt serves as backdoor equity financing (Stein (1992)). Examining the conversion price in relation to current stock prices and a priori growth expectations produces an average expected time of less than 1.5 years for convertible bonds to be at-the-money. Thus, as Stein suggests, convertibles appear to be a method of drawing equity into a firm's capital structure. We also find that the size of the firm's announcement period abnormal returns is positively related to the expected time for the convertible to become at-the-money. Given these relationships, we conclude that convertible debt issue announcements, on average, send an equity-like signal to the market.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 30 , Issue 3 , September 1995 , pp. 425 - 440
Copyright
Copyright © School of Business Administration, University of Washington 1995

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. Jr. “Equity Issues and Offering Dilution.” Journal of Financial Economics, 15 (01 1986), 61–89.CrossRefGoogle Scholar
Brennan, M. J., and Schwartz, E. S.. “Convertible Bonds: Valuation and Optimal Strategies for Call and Conversion.” Journal of Finance, 32 (12 1977), 1699–1715.CrossRefGoogle Scholar
Brennan, M. J., and Schwartz, E. S.. “Analyzing Convertible Bonds.” Journal of Financial and Quantitative Analysis, 15 (11 1980), 907–929.CrossRefGoogle Scholar
Brigham, E. F. “An Analysis of Convertible Debentures: Theory and Some Empirical Evidence.” Journal of Finance, 21 (03 1966), 35–54.Google Scholar
Broman, K. L. “The Use of Convertible Subordinated Debentures by Industrial Firms 1949–1959.” Quarterly Review of Economics and Business, 3 (Spring 1963), 65–75.Google Scholar
Cox, J. C., and Rubenstein, M.. Options Markets. Englewood Cliffs, NJ.: Prentice-Hall, Inc. (1985).Google Scholar
Dann, L. Y. “Common Stock Repurchases: An Analysis of Returns to Bondholders and Stockholders.” Journal of Financial Economics, 9 (06 1981), 113–138.CrossRefGoogle 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
Dodd, P., and Warner, J. B.. “On Corporate Governance.” Journal of Financial Economics, 11 (04 1984), 401–438.CrossRefGoogle Scholar
Eckbo, B. E. “Valuation Effects of Corporate Debt Offerings.” Journal of Financial Economics, 15 (01 1986), 119–152.CrossRefGoogle Scholar
Fields, L. P., and Mais, E. L.. “The Valuation Effects of Private Placements on Convertible Debt.” Journal of Finance, 47 (12 1991), 1925–1932.Google Scholar
Healy, P. M., and Palepu, K. G.. “Earnings and Risk Changes Surrounding Primary Stock Offers.” Journal of Accounting Research, 28 (Spring 1990), 25–48.CrossRefGoogle Scholar
Hoffmeister, J. R. “Use of Convertible Debt in the Early 1970's: A Reevaluation of Corporate Motives.” Quarterly Review of Economics and Business, 17 (Summer 1977), 21–31.Google Scholar
Hull, J. C.Options, Futures, and Other Derivative Securities. Englewood Cliffs, NJ.: Prentice-Hall, Inc. (1989).Google Scholar
Ingersoll, J. E. Jr. “An Examination of Corporate Call Policies on Convertible Securities.” Journal of Finance, 32 (06 1977), 463–478.CrossRefGoogle Scholar
Israel, R.; Ofer, A. R.; and Siegel, D. R.. “The Empirical Content of Equity for Debt Swaps: An Investigation of Analysts Forecasts of Firm Cash Flows.” Journal of Financial Economics, 25 (08 1989), 349–370.CrossRefGoogle Scholar
Jaffee, D., and Shleifer, A.. “Costs of Financial Distress, Delayed Calls and Convertible Bonds, and the Role of Investment Banks.” Journal of Business, 63 (01 1990), S107–S123.CrossRefGoogle Scholar
Janjigian, V. “The Leverage Changing Consequences of Convertible Debt Financing.” Financial Management, 16 (Fall 1987), 15–21.CrossRefGoogle Scholar
Kim, Y. O. “Informative Conversion Ratios: A Signalling Approach.” Journal of Financial and Quantitative Analysis, 25 (06 1990), 229–243.CrossRefGoogle Scholar
Masulis, R. W. “The Impact of Capital Structure Change on Firm Value: Some Estimates.” Journal of Finance, 38 (03 1983), 107–126.CrossRefGoogle Scholar
Mikkelson, W. H. “Convertible Calls and Security Returns.” Journal of Financial Economics, 9 (09 1981), 237–264.CrossRefGoogle Scholar
Mikkelson, W. H., and Partch, M. M.. “Valuation of Effects of Security Offerings and the Issuance Process.” Journal of Financial Economics, 15 (01 1986), 31–60.CrossRefGoogle Scholar
Miller, M. H., and Rock, K.. “Dividend Policy under Asymmetric Information.” Journal of Finance, 40 (09 1984), 1031–1051.CrossRefGoogle Scholar
Myers, S. C., and Majluf, N. S.. “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
Pinegar, J. M., and Lease, R. C.. “The Impact of Preferred-for Common Exchange Offers on Firm Value.” Journal of Finance, 41 (09 1986), 795–814.Google Scholar
Ross, S. A. “The Determinants of Capital Structure: The Incentive Signalling Approach.” Bell Journal of Economics and Management Science, 8 (1977), 23–40.CrossRefGoogle Scholar
Stein, J. C. “Convertible Bonds As Backdoor Equity Financing.” Journal of Financial Economics, 32 (08 1992), 3–22.CrossRefGoogle Scholar
Vermaelen, T. “Common Stock Repurchases and Market Signalling: An Empirical Study.” Journal of Financial Economics, 9 (06 1981), 138–183.CrossRefGoogle Scholar
White, H. “A Heteroskedasticity Consistent Covariance Matrix Estimator and a Direct Test of Heteroskedasticity.” Econometrika, 48 (06 1980), 817–838.CrossRefGoogle Scholar