Premium
CONVERTIBLE DEBT AND INVESTMENT INCENTIVES
Author(s) -
Harikumar T.,
Kadapakkam P.,
Singer Ronald F.
Publication year - 1994
Publication title -
journal of financial research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.319
H-Index - 49
eISSN - 1475-6803
pISSN - 0270-2592
DOI - 10.1111/j.1475-6803.1994.tb00171.x
Subject(s) - convertible bond , incentive , dividend , debt , convertible , business , monetary economics , covenant , investment (military) , economics , financial system , finance , microeconomics , philosophy , theology , politics , political science , law , engineering , structural engineering
In this paper we examine the effect of convertible debt on the investment incentives facing stockholders. The effect depends critically on the value of existing assets relative to the firm's investment requirements. With a restrictive dividend covenant, convertible debt mitigates the overinvestment incentive associated with risky debt but exacerbates the underinvestment incentive at higher values of existing assets. A less‐restrictive dividend covenant exacerbates overinvestment under straight debt financing but reduces the underinvestment incentive induced by the conversion feature. In this context, a convertible debt contract with a less‐restrictive dividend covenant maximizes firm value.