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Convertible Debt And Investment Incentives

Author

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  • T. Harikumar
  • P. Kadapakkam
  • Ronald F. Singer

Abstract

In this paper we examine the effect of convertible debt on the investment incentives facing stockholders. The effect depends critically on the value of existing assets relative to the firm's investment requirements. With a restrictive dividend covenant, convertible debt mitigates the overinvestment incentive associated with risky debt but exacerbates the underinvestment incentive at higher values of existing assets. A less‐restrictive dividend covenant exacerbates overinvestment under straight debt financing but reduces the underinvestment incentive induced by the conversion feature. In this context, a convertible debt contract with a less‐restrictive dividend covenant maximizes firm value.

Suggested Citation

  • T. Harikumar & P. Kadapakkam & Ronald F. Singer, 1994. "Convertible Debt And Investment Incentives," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 17(1), pages 15-29, March.
    • Handle: RePEc:bla:jfnres:v:17:y:1994:i:1:p:15-29
    DOI: 10.1111/j.1475-6803.1994.tb00171.x
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    Cited by:

    1. Ed-Dafali, Slimane & Patel, Ritesh & Iqbal, Najaf, 2023. "A bibliometric review of dividend policy literature," Research in International Business and Finance, Elsevier, vol. 65(C).
    2. Iyer, Subramanian R. & Sankaran, Harikumar & Nejadmalayeri, Ali, 2017. "CEO overconfidence and agency cost of debt: An empirical analysis of CEO turnover events," The North American Journal of Economics and Finance, Elsevier, vol. 42(C), pages 300-313.

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