I thank Jayant Kale (the editor), David Mauer (the referee), Michael Barclay, Joseph Golec, Thomas O’Brien, Clifford Smith, and Jerold Warner for valuable comments and suggestions.
CONVERTIBLE DEBT AND RISK-SHIFTING INCENTIVES
Version of Record online: 16 NOV 2009
© 2009 The Southern Finance Association and the Southwestern Finance Association
Journal of Financial Research
Volume 32, Issue 4, pages 423–447, Winter 2009
How to Cite
Eisdorfer, A. (2009), CONVERTIBLE DEBT AND RISK-SHIFTING INCENTIVES. Journal of Financial Research, 32: 423–447. doi: 10.1111/j.1475-6803.2009.01256.x
- Issue online: 16 NOV 2009
- Version of Record online: 16 NOV 2009
I argue that convertible debt, in contrast to its perceived role, can produce shareholders’ risk-shifting incentives. When a firm's capital structure includes convertible debt, every investment decision affects not only the distribution of the asset value but also the likelihood that the debt will be converted and thereby the distribution of the firm's leverage. This suggests that managers can engage in risk-increasing projects if a higher asset risk generates a more favorable distribution of leverage. Empirical evidence using 30 years of data supports my argument.