Why firms use convertibles: A further test of the sequential-financing hypothesis

Shao-Chi Chang, Sheng Syan Chen, Yichen Liu

Research output: Contribution to journalArticle

28 Citations (Scopus)

Abstract

The sequential-financing hypothesis advanced by Mayers [J. Financ. Econ. 47 (1998) 83] suggests that convertibles are more valuable for issuing firms with focused activities. The hypothesis also suggests that firms may design their convertibles so that there are sufficient internal funds for future investment expenditures so as to avoid the costs of accessing capital markets. This paper provides direct evidence for these two predictions. We find that the stock market responds more favorably to the announcements of convertible offerings by focused firms than to those by diversified firms. This finding holds even after controlling for other potential explanatory variables. We also find that the issuing firms' net new financing is not significantly different from zero over the life of the convertible debt. Thus, our results provide further support for the sequential-financing hypothesis that convertible debt financing is motivated by a desire to minimize security issue costs and agency costs of overinvestment for firms with promising growth opportunities to finance a sequence of potential investment options.

Original languageEnglish
Pages (from-to)1163-1183
Number of pages21
JournalJournal of Banking and Finance
Volume28
Issue number5
DOIs
Publication statusPublished - 2004 May 1

Fingerprint

Sequential financing
Convertible debt
Debt financing
Cost of capital
Prediction
Issue costs
Security issues
Announcement
Capital markets
Growth opportunities
Overinvestment
Stock market
Agency costs
Finance
Diversified firms
Expenditure
Financing

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Cite this

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Why firms use convertibles : A further test of the sequential-financing hypothesis. / Chang, Shao-Chi; Chen, Sheng Syan; Liu, Yichen.

In: Journal of Banking and Finance, Vol. 28, No. 5, 01.05.2004, p. 1163-1183.

Research output: Contribution to journalArticle

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