The Relationship of G-Index and Convertible Debt Issuance in the Presence of Restrictive Covenants

Abstract

We examine the relationship between the Governance Index (G-Index) and convertible bond
use by firms, specifically in the presence or absence of covenants. We find that the better the
shareholder governance (lower G-Index) of firms, the more they are likely to issue convertible
instead of straight bonds. More importantly, we find that the complementary relationship
between shareholder governance and convertible bond use is driven by the existence of certain
covenants attached to these convertible securities. We also find that this effect is accentuated
in firms with smaller size, higher market-to-book, R&D and intangibles as well as higher beta.
We conclude that this link between strong shareholder rights and increased convertible bond
use is conditional on the presence of covenants and therefore shows the important interaction
of these three governance mechanisms. In addition, this triple link being emphasized in firms
with higher agency costs and adverse selection problems is consistent with value-maximizing
use of convertible bonds.

Keywords: Governance Index (G-Index), Convertible Bonds, Hybrid Securities, Bond Covenants, Corporate Governance

JEL Classification: G30, G32,G34