A Theory of Mandatory Convertibles: Distinct Features for Large Repeated Financing

Abstract

In recent years, mandatory convertibles are becoming a popular means of raising capital, especially for large companies. This paper is the first theoretical paper to investigate mandatory convertibles using the incomplete-contract approach. We show that mandatory convertibles can be an efficient instrument in sequential financing. Mandatory convertibles have some distinct features than other convertibles, such as mandatory conversion, a high dividend rate, and capped capital appreciation. We show in theory that these features are designed to achieve efficiency.