Capital Structure Pre-Balancing: Evidence from Convertible Bonds

37 Pages Posted: 28 Dec 2011 Last revised: 18 Jun 2015

See all articles by Mahdi Rastad

Mahdi Rastad

Orfalea College of Business, California State Polytechnic University

Date Written: December 28, 2015

Abstract

A large body of the corporate finance literature is devoted to capital structure. This literature examines whether firms have a target capital structure, and whether they actively rebalance their capital structure towards a target. Conversion of a convertible bond causes a drop in leverage, which target capital structure theory suggests should be rebalanced in the future. Consistently, I find that following a realized conversion, firms rebalance their positions in less than a year. When the stock price passes the conversion price threshold for a convertible bond, the firm expects this drop in leverage to occur in the near future. Using a regression discontinuity design around the conversion price threshold, for those conversions that are decided by investors, not by the firm my paper documents a 21% increase in leverage before an actual drop in leverage. That is to say, firms do not wait for the realization of leverage shocks, but rather respond to anticipated shocks. A quantile treatment effect analysis reveals the effect to be a hump-shaped function of leverage, with a peak for firms with a leverage ratio around the 70th percentile.

Keywords: Convertible Bonds, Capital Structure, Regression Discontinuity, Financing Policy

JEL Classification: G32, C31

Suggested Citation

Rastad, Mahdi, Capital Structure Pre-Balancing: Evidence from Convertible Bonds (December 28, 2015). Available at SSRN: https://ssrn.com/abstract=1977511 or http://dx.doi.org/10.2139/ssrn.1977511

Mahdi Rastad (Contact Author)

Orfalea College of Business, California State Polytechnic University ( email )

San Luis Obispo, CA 93407
United States

HOME PAGE: http://www.cob.calpoly.edu/faculty/mahdi-rastad/

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