Abstract

We explore the idea that certain convertible bond offerings are basically back‐door equity offerings. We examine several methods of detecting equity components in convertible bonds and then test for market reactions to the offering announcements and also long‐run post offering performances. By dividing the sample of convertible bond offerings into a debt‐like versus equity‐like portfolio, we find market reactions follow a hierarchy predicted by the pecking order hypothesis. Consistent with empirical evidence from equity offerings, we find that the buy and hold stock returns of the equity‐like portfolio significantly underperforms as compared to that of the debt‐like portfolio. Similarly, the operating performance of the equity‐like portfolio is worse than that of the debt‐like counterpart. In addition, we find that the equity‐like portfolio’s idiosyncratic risk increase significantly after the offering. Our results suggest that the market participants are able to determine whether the convertible bond offerings are indeed back‐door equity offerings.

Citations