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Costs of Financial Distress, Delayed Calls of Convertible Bonds, and the Role of Investment Banks
Dwight M. Jaffee,Andrei Shleifer +1 more
TLDR
In this paper, the authors show that the observed delays can be plausibly explained in terms of costs to shareholders of a failed conversion and the ensuing financial distress, and explain the common use of investment banks to underwrite these transactions since the banks can eliminate the self-fulfilling bad outcome.Abstract:
In a frictionless market with perfect information, a shareholder-wealth- maximizing firm should force conversion of its convertible bond issue into stock as soon as the bond comes in-the-money. Firms however appear to systematically delay forced conversion, sometimes for years, beyond this time. We show that the observed delays can be plausibly explained in terms of costs to shareholders of a failed conversion and the ensuing financial distress. Firms delay the forced conversion to avoid the self-fulfilling outcome that bondholders expect the conversion to fail, tender their bonds for cash, and the stock price falls to account for the costs of financial distress, in which case tendering for cash is in fact optimal. Unlike other explanations of delayed forced conversion, we can explain the common use of investment banks to underwrite these transactions, since the banks can eliminate the self-fulfilling bad outcome.read more
Citations
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Convertible bonds as backdoor equity financing
TL;DR: In this paper, the authors argue that corporations may use convertible bonds as an indirect way to get equity into their capital structures when adverse-selection problems make a conventional stock issue unattractive.
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Convertible Bonds Are Not Called Late
TL;DR: The authors showed that most convertible bonds, given their call protection, are called as soon as possible and that there are significant cash flow advantages to delaying, and that the median call delay for all convertible bonds is less than four months.
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Signaling with Convertible Debt
TL;DR: In this paper, the conversion price of a convertible bond is examined in relation to current stock prices and a priori growth expectations, and it is shown that the size of the announcement period abnormal returns is positively related to the expected time for the convertible to become at-the-money.
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Liquidity Costs and Stock Price Response to Convertible Security Calls
TL;DR: In this paper, an explanation based on liquidity costs was proposed to explain the call announcement effect and the average share price decline is short-lived, lasting most of the conversion period, indicating that investors who choose to sell their shares early in the conversion process bear liquidity costs by selling at reduced prices.
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Convertible debt: an effective financial instrument to control managerial opportunism
TL;DR: In this paper, the superiority of convertible debt to common debt and equity in controlling managerial opportunism was discussed, and it was shown that well-designed callable convertible debt has an important role in controlling management opportunistic behavior that neither common debt nor equity has.
References
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Bank Runs, Deposit Insurance, and Liquidity
TL;DR: The authors showed that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits, and showed that there are circumstances when government provision of deposit insurance can produce superior contracts.
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Do Demand Curves for Stocks Slope Down
TL;DR: This article found that stocks newly included into the Standard and Poor's 500 Index have a significant positive abnormal return at the announcement of the inclusion, and this return does not disappear for at least ten days after the inclusion.
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Price and Volume Effects Associated with Changes in the S&P 500 List: New Evidence for the Existence of Price Pressures
Lawrence Harris,Eitan Gurel +1 more
TL;DR: In this paper, the authors examined the effect of price changes in the composition of the S&P 500 on the stock market and found that prices increased by more than 3 percent after an addition is announced and nearly fully reversed after two weeks.
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