Usage of convertible and warrant bonds by Japanese firms: risks shifting or delayed equity?

Abstract

This paper examines the risk-shifting and delayed enquiry explanations for Japanese firms using convertible securities in their financing mix. The popularity of equity-linked debt instruments in Japan where institutional arrangements mitigate the incentives to transfer wealth from bondholders to stockholders seems inconsistent with the risk-shifting explanation. Also the probability of choosing convertible securities over common equity is not positively related to the potential to transfer wealth from the bondholders to the stockholders. Similar results are obtained when we examine convertible debt ratios. However, we find evidence consistent with delayed equity argument that firms use convertibles to delay equity when they have favorable information about the firm. The price increases preceding and following convertible issues and convertible usage are positively related to offering size and growth opportunities as predicted by delayed equity explanations. Overall, our findings support the delayed-enquiry explanation for Japanese firms issuing convertibles, but provide little support for the risk-shifting hypothesis.