Convertible Debt and Shareholder Incentives

43 Pages Posted: 10 Oct 2012 Last revised: 19 Nov 2018

See all articles by Christian Dorion

Christian Dorion

HEC Montreal

Pascal Francois

HEC Montreal - Department of Finance

Gunnar Grass

HEC Montréal

Alexandre Jeanneret

HEC Montréal

Date Written: September 27, 2013

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.

Keywords: Convertible bonds, Risk-shifting, Asset substitution, Agency conflict, Financial distress, Asset volatility, Contingent claims

JEL Classification: G12, G32

Suggested Citation

Dorion, Christian and Francois, Pascal and Grass, Gunnar and Jeanneret, Alexandre, Convertible Debt and Shareholder Incentives (September 27, 2013). Journal of Corporate Finance, (24) 2014. Available at SSRN: https://ssrn.com/abstract=2159478 or http://dx.doi.org/10.2139/ssrn.2159478

Christian Dorion

HEC Montreal ( email )

3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H2X 2L3
Canada
5143401522 (Phone)
5143405632 (Fax)

HOME PAGE: http://neumann.hec.ca/pages/christian.dorion/

Pascal Francois

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

Gunnar Grass (Contact Author)

HEC Montréal ( email )

3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H3T2A7
Canada
5143401540 (Phone)

Alexandre Jeanneret

HEC Montréal ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

HOME PAGE: http://www.alexandrejeanneret.com

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