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- Publisher
- Emerald Publishing
- Copyright
- Copyright © 2004 Emerald Group Publishing Limited. All rights reserved.
- ISSN
- 0307-4358
- DOI
- 10.1108/03074350410769425
- Publisher site
- See Article on Publisher Site
Abstract
Several researchers have found that the value of stock declines at the announcement of a debt for equity swap. This decline is attributed to an information effect: the firm’s financial condition is worse than the market expected. Our research develops an alternative explanation. Using the theory that equity can be valued as an option on the firm, it is shown that, depending on the exchange ratio, a debt for equity swap will cause the price of the stock to decline. This theory is tested using a sample of firms that announced debt for common equity swaps. The theoretically predicted stock price reactions are consistent with the actually observed stock price reactions. Furthermore, the contingent claims model has better explanatory power than a simple model of dilution. Tests on the sensitivity to the assumptions of the option pricing model show that only the assumption of the time to expiration of the option significantly affects the results.
Journal
Managerial Finance – Emerald Publishing
Published: Dec 1, 2004
Keywords: Equity capital; Economic theory; Derivative markets