Convertible Bond Calls: Resolution of the Information Content Puzzle

Abstract

This study resolves the puzzling evidence on convertible bonds by documenting that conversion-forcing calls are indeed bad news. Supporting the long-term implications of Harris and Raviv (1985), we document that the common stocks of calling firms substantially underperform their benchmarks by a median of 64% over the five-year post-call period. In contrast, firms that choose not to call their in-the-money convertibles exhibit no long-run abnormal performance. We show that studies drawing conclusions based on short-term price reversal immediately following the call fail to completely capture the valuation effect that occurs over a longer time horizon. We document that the market condition at the time of the call (issuance volume) and cash flow benefits related to the call (relation between dividend and after tax coupon payment) influence the post-call stock price performance. Our analysis also reveals that the post-call underperformance of high-growth firms is more pronounced than that of low-growth firms, indicating greater market exuberance associated with high-growth firms at the time of the call.

Keywords: Convertible bond calls, Information content of convertible calls, Long-run post-call underperformance

JEL Classification: G14, G32