Convertibles and Hedge Funds as Distributors of Equity Exposure
Stephen J. Brown
New York University - Stern School of Business
Bruce D. Grundy
University of Melbourne
Craig M. Lewis
Vanderbilt University - Finance
Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)
January 21, 2011
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.
Number of Pages in PDF File: 53
Keywords: Convertible securities, convertible arbitrage, hedge funds
JEL Classification: G2, G32
Date posted: March 11, 2010 ; Last revised: November 23, 2012
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