Convertible Bond Issues: Evidence from Security Markets

Abstract

A convertible bond (CB) is a hybrid security containing elements of both common stock and straight debt. Still, empirical investigations on CB issue announcements have failed to discern any pattern in the stock market reaction that is consistent with announcements of either common equity or straight debt issues. This study shows that (a) motives for issuing the CB and (b) its rating (and to a less extent the riskiness of the issuing firm) help explain the stock market reaction to CB issue announcements. Specifically, announcement of a CB issue with an explicitly stated motive for the use of proceeds, when coupled with a high (low) bond rating, generates a stock market response similar to a straight debt (common stock) issue. On the other hand, the preference of CB holders is dictated by the motive for the use of proceeds and the conversion premium. These findings highlight the critical importance of the motive of issue in determining reactions in both the stock and bond markets.

Changes in risk characteristics of firms issuing hybrid securities: case of convertible bonds

“…Relating the ratings of the convertible bond issue with abnormal returns, they found that higher rated convertible bonds had larger negative returns (−3.72 per cent), whereas lower rated convertible bond issues had less negative returns (−0.14 per cent) for a 2 day period around the announce date. Mehta and Khan (1995) extended the work of Mikkelson and Partch (1986) by considering an enlarged sample size (166 firms) and found similar negative returns. They also related abnormal returns with ratings of the bond.…”

“…These returns are less negative than negative returns found for firms issuing equity (see Dann and Mikkelson, 1984;Eckbo, 1986;Mikkelson and Partch, 1986;Hansen and Crutchley, 1990;Abhyankar and Dunning, 1999). Several studies have documented that returns are more negative for higher rated bonds and firms with lower Value Line ratings (see Mikkelson and Partch, 1986;Davidson et al, 1995;Mehta and Khan, 1995). Firms that use funds from issuance of convertible bonds for capital expenditure rather than to retire debt had higher returns (Abhyankar and Dunning, 1999).…”

The Consequences of Issuing Convertible Bonds: Dilution and/or Financial Restructuring?

“…In parallel with the generally negative market reaction to CB issues, we can also mention other empirical studies attributing the market reaction according to various specific variables. Following the work initiated by Eckbo (1986) or Mehta and Kahn (1995) in the US market, Ducassy (2003) points out that the French market reaction depends on the use of funds received from the CB issue. This reaction is very negative when future investments are announced, but it becomes non‐significant when it is a matter of financial restructuring (lowering the debt ratio).…”

“…(1999) for the US market; Abhyankar and Dunning (1999) for the UK market and Ducassy (2003) for the French market). The firm's risk, whether it is measured by the beta (Mehta and Kahn, 1995) or by the volatility of return (Lewis et al ., 1999), results in market reactions that are magnified for the US market and unchanged for the French market (Ducassy, 2003). Just as Lewis et al .…”

Valuing primary issue convertible bonds: Evidence from China

“…Based on the financial theories and previous studies (Mehta and Khan, 26 Datta et al, 27 Kang and Lee 28 ), we propose the following 27 variables that can have an impact on the value of primary issue CBs:…”