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Financial reporting, debt covenants and convertible debts

Financial reporting, debt covenants and convertible debts This study proposes an alternative perspective on why firms issue convertible debt, to supplement the largely theoretical motives identified in the existing literature. It hypothesises that the separate presentation of convertible debt into its equity and liability components has economic consequences and advantage that explain why firms issue convertible over non-convertible debt, consistent with the debt covenant hypothesis. The purpose of this paper is to address the proposed perspective and hypothesis.Design/methodology/approachData on convertible debt, gearing (debt assets and debt equity), debt issuance and retirement, etc. were collected for a sample of 1,104 firms listed on Bursa Malaysia. Regression analyses were then used to assess the hypotheses on how gearing affects the use of convertible debt and the impacts of its use on changes in gearing over the financing cycle.FindingsFirms with higher gearing, and possibly those close to violating debt covenants, are more likely to issue convertible than non-convertible debt. In addition, the use of convertible rather than non-convertible debt both reduces the increase in gearing when debts are issued and leads to a larger decrease in gearing during debt retirements via conversion.Practical implicationsThese effects on gearing provide firms with additional financial flexibility and enhance firms' capacity to borrow more from other sources, a lower-debt advantage.Originality/valueThis study demonstrates the informational role of financial reporting in addressing the stewardship emphasis, as part of the decision usefulness objective of financial reporting in the Conceptual Framework for Financial Reporting. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Asian Review of Accounting Emerald Publishing

Financial reporting, debt covenants and convertible debts

Lau, Chee Kwong
Asian Review of Accounting , Volume 31 (2): 20 – Mar 20, 2023
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20 pages

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Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1321-7348
DOI
10.1108/ara-05-2022-0126
Publisher site
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Abstract

This study proposes an alternative perspective on why firms issue convertible debt, to supplement the largely theoretical motives identified in the existing literature. It hypothesises that the separate presentation of convertible debt into its equity and liability components has economic consequences and advantage that explain why firms issue convertible over non-convertible debt, consistent with the debt covenant hypothesis. The purpose of this paper is to address the proposed perspective and hypothesis.Design/methodology/approachData on convertible debt, gearing (debt assets and debt equity), debt issuance and retirement, etc. were collected for a sample of 1,104 firms listed on Bursa Malaysia. Regression analyses were then used to assess the hypotheses on how gearing affects the use of convertible debt and the impacts of its use on changes in gearing over the financing cycle.FindingsFirms with higher gearing, and possibly those close to violating debt covenants, are more likely to issue convertible than non-convertible debt. In addition, the use of convertible rather than non-convertible debt both reduces the increase in gearing when debts are issued and leads to a larger decrease in gearing during debt retirements via conversion.Practical implicationsThese effects on gearing provide firms with additional financial flexibility and enhance firms' capacity to borrow more from other sources, a lower-debt advantage.Originality/valueThis study demonstrates the informational role of financial reporting in addressing the stewardship emphasis, as part of the decision usefulness objective of financial reporting in the Conceptual Framework for Financial Reporting.

Journal

Asian Review of Accounting – Emerald Publishing

Published: Mar 20, 2023

Keywords: Convertible debt; Financial reporting; Debt covenant hypothesis; Economic consequences; Separate presentation

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