Agency Problems, Information Asymmetries, and Convertible Debt Security Design

Abstract

This paper proposes and implements a security design framework to assess why corporate managers issue convertible debt. We examine three theories that make predictions about the design of convertible debt. Our results suggest that some issuers design convertible debt to mitigate asset substitution problems, while others design it to reduce adverse selection problems. We also find that issuers vary convertible debt security design over the business cycle in response to time-variation in asset substitution and adverse selection problems. Overall, the results indicate that corporate managers actively alter convertible debt security design to mitigate costly external finance problems.

JEL Classification: G32