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THE CASE FOR CONVERTIBLES *

THE CASE FOR CONVERTIBLES * Footnotes 1 . This example is not meant to suggest that because the terms of the two convertible issues are nearly identical, the cost of the convertible is identical for the two companies Remember that convertible debt is a hybrid security, partly straight debt and partly (a call option on the company's) equity. The opportunity cost of a convertible debt issue should thus be thought of 215 a weighted average of the company's cost of debt and equity capital For the higher‐risk company in this example, the fact that it has both a higher cost of straight debt and a higher implicit cost of equity suggests that in convertible will have a higher implicit cost. But, more important, the fact that a much greater portion of the value of its convertible more important, the fact that a much greater portion of the value of its convertible been promised a more substantial equity stake in the higher‐risk company this, of course, translates into a higher opportunity cost of capital. 2 . This argument was first presented formally by Michael C. Jensen and William H. Meckling in “ Theory of the Firm Managerial Behavior, Agency Costs, and Capital Structure ,” http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Applied Corporate Finance Wiley

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References (6)

Publisher
Wiley
Copyright
Copyright © 1988 Wiley Subscription Services, Inc., A Wiley Company
ISSN
1078-1196
eISSN
1745-6622
DOI
10.1111/j.1745-6622.1988.tb00166.x
Publisher site
See Article on Publisher Site

Abstract

Footnotes 1 . This example is not meant to suggest that because the terms of the two convertible issues are nearly identical, the cost of the convertible is identical for the two companies Remember that convertible debt is a hybrid security, partly straight debt and partly (a call option on the company's) equity. The opportunity cost of a convertible debt issue should thus be thought of 215 a weighted average of the company's cost of debt and equity capital For the higher‐risk company in this example, the fact that it has both a higher cost of straight debt and a higher implicit cost of equity suggests that in convertible will have a higher implicit cost. But, more important, the fact that a much greater portion of the value of its convertible more important, the fact that a much greater portion of the value of its convertible been promised a more substantial equity stake in the higher‐risk company this, of course, translates into a higher opportunity cost of capital. 2 . This argument was first presented formally by Michael C. Jensen and William H. Meckling in “ Theory of the Firm Managerial Behavior, Agency Costs, and Capital Structure ,”

Journal

Journal of Applied Corporate FinanceWiley

Published: Jun 1, 1988

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