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Convertible debt and shareholder incentives

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  • Dorion, Christian
  • François, Pascal
  • Grass, Gunnar
  • Jeanneret, Alexandre

Abstract

Given equity's convex payoff function, shareholders can transfer wealth from bondholders by increasing firm risk. We test the existing hypothesis that convertible debt reduces this classical agency problem of risk-shifting. First, we derive a measure of shareholders' risk incentives induced by convertible debt using a contingent claims framework. We then document that when risk-shifting incentives are high, the propensity to issue convertible (rather than straight) debt increases and the negative stock market reaction following convertible debt issue announcements is amplified. We further highlight that convertible debt is the only type of security that affects business risk durably downwards. Our conclusions support the agency theoretic rationale for convertible debt financing especially for financially distressed firms.

Suggested Citation

  • 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.
    • Handle: RePEc:eee:corfin:v:24:y:2014:i:c:p:38-56
    DOI: 10.1016/j.jcorpfin.2013.10.008
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    4. 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.
    5. 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.
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    More about this item

    Keywords

    Convertible bonds; Risk-shifting; Agency conflict; Financial distress; Asset volatility; Contingent claims;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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