Improving the prevention of environmental risks with convertible bonds

Abstract

This paper considers a limited liability firm that needs external funds in order to invest in an activity that presents an environmental risk for the Society. When the firm's risk-reducing activities cannot be observed by the lenders, we show that the issue of convertible bonds can create incentives to improve prevention. Convertible bonds allow the holder to exchange his bonds for a fixed number of the firm's shares. The use of such hybrid securities could either complement or be an alternative to the American CERCLA legislation about lender extended liability. We define an optimal convertible bond contract that induces unchanged economic profits for the bank, more prevention and higher expected net revenues for the firm and a higher expected social welfare than with standard debt. Our results hold true both with and without extended liability. r 2005 Elsevier Inc. All rights reserved.

Professionals' Perspectives of Corporate Social Responsibility

“…The second category of strategies is based on the view that banks consume significant amounts of paper, energy, water, plastic and other resources. Such products include loans for investments in new environmentally friendly technology and equipment, 'environmental' mutual funds, green charge cards, and specific bonds (Boyer and Laffont, 1997;Laundgren and Catasus, 2000;Schmitt and Spaeter, 2005). According to Weiler et al (1997), such environmental strategies may be the implementation of ISO 14001 and EMAS.…”