IDEAS home Printed from https://ideas.repec.org/a/eee/corfin/v17y2011i4p809-831.html
   My bibliography  Save this article

Convertible security design and contract innovation

Author

Listed:
  • Lewis, Craig M.
  • Verwijmeren, Patrick

Abstract

This paper studies convertible security design for a sample of 814 issuers over the years 2000 through 2007. Using a nested logit model, we examine how firms choose fixed income claims and the method of payment. We find that fixed income claims are chosen to reduce corporate income taxes, minimize refinancing costs, and help mitigate managerial discretion costs. The method of payment choice frequently includes cash settlement features because they increase reported diluted earnings per share. Some of the cash settlement issuers also adopt other innovative financial strategies (share repurchase programs and call spread overlays) that inflate reported earnings per share. We find that firms needing debt capacity include mandatory conversion features.

Suggested Citation

  • Lewis, Craig M. & Verwijmeren, Patrick, 2011. "Convertible security design and contract innovation," Journal of Corporate Finance, Elsevier, vol. 17(4), pages 809-831, September.
    • Handle: RePEc:eee:corfin:v:17:y:2011:i:4:p:809-831
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0929119911000162
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Stein, Jeremy C., 1992. "Convertible bonds as backdoor equity financing," Journal of Financial Economics, Elsevier, vol. 32(1), pages 3-21, August.
    2. Green, Richard C., 1984. "Investment incentives, debt, and warrants," Journal of Financial Economics, Elsevier, vol. 13(1), pages 115-136, March.
    3. Hribar, Paul & Jenkins, Nicole Thorne & Johnson, W. Bruce, 2006. "Stock repurchases as an earnings management device," Journal of Accounting and Economics, Elsevier, vol. 41(1-2), pages 3-27, April.
    4. An Yan & Debarshi Nandy & Thomas Chemmanur, 2004. "Why Issue Mandatory Convertibles? Theory and Empirical Evidence," Econometric Society 2004 North American Winter Meetings 456, Econometric Society.
    5. DeAngelo, Harry & Masulis, Ronald W., 1980. "Optimal capital structure under corporate and personal taxation," Journal of Financial Economics, Elsevier, vol. 8(1), pages 3-29, March.
    6. Carol Marquardt & Christine Wiedman, 2005. "Earnings Management through Transaction Structuring: Contingent Convertible Debt and Diluted Earnings per Share," Journal of Accounting Research, Wiley Blackwell, vol. 43(2), pages 205-243, May.
    7. Lewis, Craig M. & Rogalski, Richard J. & Seward, James K., 2001. "The long-run performance of firms that issue convertible debt: an empirical analysis of operating characteristics and analyst forecasts," Journal of Corporate Finance, Elsevier, vol. 7(4), pages 447-474, December.
    8. de Jong, Abe & Dutordoir, Marie & Verwijmeren, Patrick, 2011. "Why do convertible issuers simultaneously repurchase stock? An arbitrage-based explanation," Journal of Financial Economics, Elsevier, vol. 100(1), pages 113-129, April.
    9. Craig M. Lewis & Richard J. Rogalski & James K. Seward, 1999. "Is Convertible Debt a Substitute for Straight Debt or for Common Equity?," Financial Management, Financial Management Association, vol. 28(3), Fall.
    10. Cronqvist, Henrik & Nilsson, Mattias, 2005. "The choice between rights offerings and private equity placements," Journal of Financial Economics, Elsevier, vol. 78(2), pages 375-407, November.
    11. Lewis, Craig M. & Rogalski, Richard J. & Seward, James K., 1998. "Agency Problems, Information Asymmetries, and Convertible Debt Security Design," Journal of Financial Intermediation, Elsevier, vol. 7(1), pages 32-59, January.
    12. Hillion, Pierre & Vermaelen, Theo, 2004. "Death spiral convertibles," Journal of Financial Economics, Elsevier, vol. 71(2), pages 381-415, February.
    13. Lee, Inmoo & Loughran, Tim, 1998. "Performance following convertible bond issuance," Journal of Corporate Finance, Elsevier, vol. 4(2), pages 185-207, June.
    14. Mayers, David, 1998. "Why firms issue convertible bonds: the matching of financial and real investment options," Journal of Financial Economics, Elsevier, vol. 47(1), pages 83-102, January.
    15. Asquith, Paul, 1995. "Convertible Bonds Are Not Called Late," Journal of Finance, American Finance Association, vol. 50(4), pages 1275-1289, September.
    16. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
    17. G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003. "Handbook of the Economics of Finance," Handbook of the Economics of Finance, Elsevier, edition 1, volume 1, number 1.
    18. Chen, Hsuan-Chi & Dai, Na & Schatzberg, John D., 2010. "The choice of equity selling mechanisms: PIPEs versus SEOs," Journal of Corporate Finance, Elsevier, vol. 16(1), pages 104-119, February.
    19. Lee, Hei Wai & Figlewicz, Raymond E., 1999. "Characteristics of firms that issue convertible debt versus convertible preferred stock," The Quarterly Review of Economics and Finance, Elsevier, vol. 39(4), pages 547-563.
    20. Tufano, Peter, 2003. "Financial innovation," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 6, pages 307-335, Elsevier.
    21. Peter Tufano, 2003. "Financial Innovation," Levine's Working Paper Archive 618897000000000651, David K. Levine.
    22. G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003. "Handbook of the Economics of Finance," Handbook of the Economics of Finance, Elsevier, edition 1, volume 1, number 2.
    23. repec:bla:jfinan:v:59:y:2004:i:1:p:391-405 is not listed on IDEAS
    24. Lewis, Craig M. & Rogalski, Richard J. & Seward, James K., 2003. "Industry conditions, growth opportunities and market reactions to convertible debt financing decisions," Journal of Banking & Finance, Elsevier, vol. 27(1), pages 153-181, January.
    25. Lewis, Craig M. & Rogalski, Richard J. & Seward, James K., 2002. "Risk changes around convertible debt offerings," Journal of Corporate Finance, Elsevier, vol. 8(1), pages 67-80, January.
    26. Burlacu, Radu, 2000. "New evidence on the pecking order hypothesis: the case of French convertible bonds," Journal of Multinational Financial Management, Elsevier, vol. 10(3-4), pages 439-459, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Bruce D. Grundy & Patrick Verwijmeren, 2012. "Dividend-Protected Convertible Bonds and the Disappearance," Tinbergen Institute Discussion Papers 12-060/2/DSF37, Tinbergen Institute.
    2. Finnerty, John D., 2015. "Valuing convertible bonds and the option to exchange bonds for stock," Journal of Corporate Finance, Elsevier, vol. 31(C), pages 91-115.
    3. Verwijmeren, Patrick & Yang, Antti, 2020. "The fluctuating maturities of convertible bonds," Journal of Corporate Finance, Elsevier, vol. 62(C).
    4. Angel Huerga & Carlos Rodríguez-Monroy, 2019. "Mandatory Convertible Bonds and the Agency Problem," Sustainability, MDPI, vol. 11(15), pages 1-21, July.
    5. Henderson, Brian J. & Zhao, Bo, 2014. "More than meets the eye: Convertible bond issuers' concurrent transactions," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 57-79.
    6. Dutordoir, Marie & Lewis, Craig & Seward, James & Veld, Chris, 2014. "What we do and do not know about convertible bond financing," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 3-20.
    7. Lewis, Craig M. & Veld, Chris, 2014. "Convertible bond financing," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 1-2.
    8. Christian Dorion & Pascal François & Gunnar Grass & Alexandre Jeanneret, 2014. "Convertible Debt and Shareholder Incentives," Cahiers de recherche 1403, CIRPEE.
    9. Lewis, Craig & Verwijmeren, Patrick, 2014. "Cash-settled convertible bonds and the value relevance of their accounting treatment," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 101-111.
    10. Warrick van Zyl & Enrico Uliana, 2022. "Fixing diluted earnings per share: Recognising the dilutive effects of employee stock options," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 62(2), pages 2993-3019, June.
    11. Marle, Mats van & Verwijmeren, Patrick, 2017. "The long and the short of convertible arbitrage: An empirical examination of arbitrageurs’ holding periods," Journal of Empirical Finance, Elsevier, vol. 44(C), pages 237-249.
    12. Bechmann, Ken L. & Lunde, Asger & Zebedee, Allan A., 2014. "In- and out-of-the-money convertible bond calls: Signaling or price pressure?," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 135-148.
    13. Dorion, Christian & François, Pascal & Grass, Gunnar & Jeanneret, Alexandre, 2014. "Convertible debt and shareholder incentives," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 38-56.
    14. Neil Fargher & Baljit K. Sidhu & Ann Tarca & Warrick van Zyl, 2019. "Accounting for financial instruments with characteristics of debt and equity: finding a way forward," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 59(1), pages 7-58, March.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Dutordoir, Marie & Lewis, Craig & Seward, James & Veld, Chris, 2014. "What we do and do not know about convertible bond financing," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 3-20.
    2. de Jong, Abe & Dutordoir, Marie & Verwijmeren, Patrick, 2011. "Why do convertible issuers simultaneously repurchase stock? An arbitrage-based explanation," Journal of Financial Economics, Elsevier, vol. 100(1), pages 113-129, April.
    3. Dong, Ming & Dutordoir, Marie & Veld, Chris, 2019. "How can we improve inferences from surveys? A new look at the convertible debt questions from the Graham and Harvey survey data," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 61(C), pages 213-222.
    4. Duca, Eric & Dutordoir, Marie & Veld, Chris & Verwijmeren, Patrick, 2012. "Why are convertible bond announcements associated with increasingly negative issuer stock returns? An arbitrage-based explanation," Journal of Banking & Finance, Elsevier, vol. 36(11), pages 2884-2899.
    5. Christian Dorion & Pascal François & Gunnar Grass & Alexandre Jeanneret, 2014. "Convertible Debt and Shareholder Incentives," Cahiers de recherche 1403, CIRPEE.
    6. Khalid Elbadraoui & Jean-Jacques Lilti & Bouchra M'Zali, 2008. "La performance opérationnelle à long terme des entreprises françaises émettrices d’obligations convertibles," Revue Finance Contrôle Stratégie, revues.org, vol. 11(3), pages 125-154, September.
    7. Dutordoir, M.D.R.P. & Van de Gucht, L., 2006. "Why Do Western European Firms Issue Convertibles Instead of Straight Debt or Equity?," ERIM Report Series Research in Management ERS-2006-056-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    8. Zeidler, Felix & Mietzner, Mark & Schiereck, Dirk, 2012. "Risk dynamics surrounding the issuance of convertible bonds," Journal of Corporate Finance, Elsevier, vol. 18(2), pages 273-290.
    9. Lewis, Craig & Verwijmeren, Patrick, 2014. "Cash-settled convertible bonds and the value relevance of their accounting treatment," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 101-111.
    10. King, Tao-Hsien Dolly & Mauer, David C., 2014. "Determinants of corporate call policy for convertible bonds," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 112-134.
    11. Li, Xiaoyang & Lin, Shannon & Tucker, Alan L., 2016. "The curious case of converts," Global Finance Journal, Elsevier, vol. 31(C), pages 1-17.
    12. Abhyankar, Abhay & Ho, Keng-Yu, 2006. "Long-run abnormal performance following convertible preference share and convertible bond issues: New evidence from the United Kingdom," International Review of Economics & Finance, Elsevier, vol. 15(1), pages 97-119.
    13. Dutordoir, Marie & Pappas, Kostas & Xu, Alice Liang & Zeng, Cheng (Colin), 2023. "Covenants in convertible bonds: Boon or boilerplate?," Journal of Corporate Finance, Elsevier, vol. 80(C).
    14. Henderson, Brian J. & Zhao, Bo, 2014. "More than meets the eye: Convertible bond issuers' concurrent transactions," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 57-79.
    15. Dorion, Christian & François, Pascal & Grass, Gunnar & Jeanneret, Alexandre, 2014. "Convertible debt and shareholder incentives," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 38-56.
    16. Kim, Hyeong Joon & Han, Seung Hun, 2019. "Convertible bond announcement returns, capital expenditures, and investment opportunities: Evidence from Korea," Pacific-Basin Finance Journal, Elsevier, vol. 53(C), pages 331-348.
    17. Suchard, Jo-Ann & Singh, Manohar, 2006. "The determinants of the hybrid security issuance decision for Australian firms," Pacific-Basin Finance Journal, Elsevier, vol. 14(3), pages 269-290, June.
    18. An Yan & Debarshi Nandy & Thomas Chemmanur, 2004. "Why Issue Mandatory Convertibles? Theory and Empirical Evidence," Econometric Society 2004 North American Winter Meetings 456, Econometric Society.
    19. Lyandres, Evgeny & Zhdanov, Alexei, 2014. "Convertible debt and investment timing," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 21-37.
    20. Marie Dutordoir & Patrick Verwijmeren, 2008. "Why do Convertible Issuers simultaneously Repurchase Stock? An Arbitrage-based Explanation," Working Papers 0802, Departament Empresa, Universitat Autònoma de Barcelona, revised Feb 2008.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:corfin:v:17:y:2011:i:4:p:809-831. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jcorpfin .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.