Financing decisions: The case of convertible bonds
Published on Jan 1, 2020in International Review of Financial Analysis1.693
· DOI :10.1016/j.irfa.2019.101393
Abstract Research studying firms' motivations to issue convertible bonds remains far from complete. This paper aims to provide further understanding of firms' motives behind issuing convertible bonds. We propose a theoretical model that explains issuers' choice between convertibles and equity when raising a required amount of capital by comparing the cash flow streams of both alternatives in order to maximize the firm's value for the current shareholders. We derive a closed form solution of our theoretical model both in absence and presence of default risk. Our model suggests that issuing convertible bonds is preferred to a direct stock issuance if the expected return of convertible bonds is lower than the expected return of common stocks. Empirical findings confirm our theoretical predictions.