Convertible Design and Contract Innovation

Abstract:     
This paper studies convertible security design for a sample of 819 issuers over the years 2000 through 2007. We examine the determinants of the choice of fixed income claim and the method of payment using a nested logit regression model. We find that firms select security designs that reduce corporate income taxes, minimize refinancing costs, and help mitigate managerial discretion costs. Convertible debt issuers frequently select payment methods that permit them to report higher diluted earnings per share. Some of these firms also adopt simultaneous financial strategies (share repurchase programs and call spread overlays) that inflate reported earnings. Firms that adopt these earnings management strategies are more likely to choose certain investment banks.

Keywords: Convertible security financing; Convertible debt; Convertible preferred stock; External finance; Security choice decision; Security design; Cash settlement; Net share settlement; Mandatory conversion.

JEL Classifications: G32, L22

Working Paper Series