Convertibles and Hedge Funds as Distributors of Equity Exposure

Abstract

By buying convertibles and shorting the underlying stock, hedge funds distribute equity exposure to well-diversified shareholders. We find that a higher fraction of a convertible is privately-placed with hedge funds when institutional ownership, stock liquidity, issue size, concurrent stock repurchases, and limitations on callability suggest that shorting costs will be lower. Firms with characteristics that make seasoned equity offerings expensive are also more likely to issue convertibles to hedge funds, and we show that firms issuing convertibles to hedge funds would have had significantly higher issue costs if they had instead chosen to issue seasoned equity. Discounts are not higher on convertibles issued to hedge funds, which is in line with hedge funds serving as relatively low-cost distributors of equity exposure rather than investors of last resort.

Keywords: Convertible securities, convertible arbitrage, hedge funds

JEL Classification: G2, G32