Asymmetric information and conversion price reset policy: The case of Chinese convertible debt

Abstract

This paper studies a firm's decision to reset the conversion price of convertible debt when the manager has asymmetric private information. Reset provisions are present uniquely in East Asian issues of convertible debt, and in practice allow a firm's management to lower the conversion price. We develop a signalling model in which a conversion price reset conveys unfavorable private information about the firm. This is because a firm will reset only if it cannot afford debt repayment. We conduct an event study with data on the equity prices of Chinese convertible bond issuing firms. We argue that conversion price resets exhibit negative announcement effects.