Risk changes around convertible debt offerings

Abstract

Firms issuing convertible debt experience poor long-run stock price and operating performance. We examine the possibility that this poor performance may be caused by an unexpected increase in the cost of capital. Our finding that the cost of capital decreases following a convertible debt offer (CDO) is inconsistent with this interpretation. We also provide evidence that idiosyncratic and total risk increases and that these increases are not related to corresponding changes in the issuer's industry. The results are consistent with an interpretation that idiosyncratic risk affects investment decisions following convertible debt offers, which in turn adversely impacts future operating performance. Our empirical evidence reinforces the notion suggested in earlier studies that the efficient investment decisions predicted by theory are not achieved by the actual design and issuance of convertible debt securities in practice.