The Determinants of Convertible Debt Issuance and Call Protection Strength: Evidence from New Corporate Borrowings

Abstract

The main purpose is to identify the determinants of convertible debt’s call provision design. We divide our study into three parts. First, we use a sample of new debt financings in 1999 and 2000 to examine the choice between convertible debt and straight debt. Our results indicate that the likelihood of issuing convertible debt compared to straight debt is higher for small firms, high technology firms, high growth firms, and high investment growth firms, which is consistent with information asymmetry and the agency costs theories. Also, consistent with financial health theory, we find that firms with poor financial slack and profitability are more likely to issue convertible debts than straight debts. Because the main object of this study is convertible debt, we don’t consider callable straight debt but only focus on convertible debt. Next, we document the determinants of call provision of new convertible debts issued between 1989 and 2000. Our main finding is that callable convertible debt issuers have better performance after issuance than noncallable debt issuers. This result is consistent with information asymmetry theory. Finally, we provide an empirical examination of determinants of convertible debt’s call protection period. We find that firms are more likely to issue convertible debt with longer call protection if they are large or high growth firms. This result is consistent with information asymmetry and earnings dilution theory that large firms issue convertible debt with longer call protection period in order to avoid earnings dilution.