A Sequential Signalling Model of Convertible Debt Call Policy

A Sequential Signalling Model of Convertible Debt Call Policy ABSTRACT In this paper we attempt to resolve two puzzles concerning convertible debt calls. The first is that although it has been shown that conversion of these bonds should optimally be forced as soon as this is feasible, actual calls are significantly delayed relative to this prescription. The second is that common stock returns are significantly negative around the announcement of the call of a convertible debt issue. Our purpose is to simultaneously rationalize managers' observed call decisions and the market's reaction to them in a framework in which managers behave optimally given their private information, compensation schemes, and investors' reactions to their call decisions. Moreover, investors' reactions are rational in the sense of Bayes' rule given managers' call policy. In equilibrium, a decision to call is (correctly) perceived by the market as a signal of unfavorable private information. In addition to rationalizing observed call delays and negative stock returns at call announcement, several other testable implications are derived. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

A Sequential Signalling Model of Convertible Debt Call Policy

The Journal of Finance, Volume 40 (5) – Dec 1, 1985

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Publisher
Wiley
Copyright
1985 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1985.tb02382.x
Publisher site
See Article on Publisher Site

Abstract

ABSTRACT In this paper we attempt to resolve two puzzles concerning convertible debt calls. The first is that although it has been shown that conversion of these bonds should optimally be forced as soon as this is feasible, actual calls are significantly delayed relative to this prescription. The second is that common stock returns are significantly negative around the announcement of the call of a convertible debt issue. Our purpose is to simultaneously rationalize managers' observed call decisions and the market's reaction to them in a framework in which managers behave optimally given their private information, compensation schemes, and investors' reactions to their call decisions. Moreover, investors' reactions are rational in the sense of Bayes' rule given managers' call policy. In equilibrium, a decision to call is (correctly) perceived by the market as a signal of unfavorable private information. In addition to rationalizing observed call delays and negative stock returns at call announcement, several other testable implications are derived.

Journal

The Journal of FinanceWiley

Published: Dec 1, 1985

References

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