Journal of Corporate Finance 24 (2014) 135–148

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Journal of Corporate Finance

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In- and out-of-the-money convertible bond calls: Signaling orprice pressure?☆

Ken L. Bechmann a,⁎, Asger Lunde b, Allan A. Zebedee c

a Department of Finance, Copenhagen Business School, Denmarkb Department of Economics and Business, Aarhus University, Denmarkc Department of Finance, Clarkson University, Potsdam, NY 13699, United States

a r t i c l e i n f o

☆ Ken L. Bechmann gratefully acknowledges the fi

referee; the editor of the special issue; Thierry FoucEFMA, EWFS, FMA conferences, the CREATES Sympo⁎ Corresponding author. Tel.: +45 3815 2953.

E-mail address: kb.fi@cbs.dk (K.L. Bechmann).

0929-1199/$ – see front matter © 2013 Elsevier B.V. Ahttp://dx.doi.org/10.1016/j.jcorpfin.2013.11.002

a b s t r a c t

Article history:Received 1 October 2012Received in revised form 31 October 2013Accepted 1 November 2013Available online 9 November 2013

Convertible bond calls typically cause significant reactions in equity prices. The empiricalresearch largely finds negative and positive announcement effects for the in-the-money andthe out-of-the-money calls respectively. However, this research has difficulty distinguishingbetween the two main theoretical explanations: the signaling effect and the price pressureeffect. In this paper, we differentiate between these two effects by using a unique data set ofthe in- and the out-of-the-money calls in the United States during the period of 1993 to 2007.We find that the announcement effect for the in-the-money call is predominantly explained bythe subsequent order imbalances; and the stock market's reaction is spread over an entiretrading day, which is consistent with the price pressure effect. In contrast, the announcementeffect for the out-of-the-money call is driven by the size of the called convertible bond; and thestock market's reaction is almost immediate, which is consistent with the signaling effect.

© 2013 Elsevier B.V. All rights reserved.

JEL classification:G14G32D82

Keywords:SignalingPrice pressureIntraday stock market reactionConvertible bond calls

1. Introduction

Based on the early work of Mikkelson (1981), numerous studies find evidence of a significant reaction from the stock marketto the announcement of convertible bond calls. In particular, these studies show that the in-the-money calls result in a negativereaction from the stock market (see, e.g., Cowan et al., 1990; Mikkelson, 1981). On the other hand, the out-of-the-money calls areassociated with a positive reaction from the stock market (Cowan et al., 1993). In this paper, we provide a comprehensiveexamination of the announcement effects of both the in- and the out-of-the-money calls by examining trade and quote dataimmediately following the announcements.

The literature suggests two different hypotheses to explain the announcement effect of convertible bond calls. The first is thesignaling effect suggested by Harris and Raviv (1985). The signaling effect is based on the asymmetry of information betweenmanagers and outside investors and assumes that outside investors infer information about the firm's prospects based on themanagement's call strategy. Specifically, in the case of the in-the-money convertible bond calls, the investors interpret themanagement's call announcement as a negative signal because the management is forcing an early conversion of the bonds toavoid having to redeem the bonds with cash later. While Harris and Raviv (1985) do not formally extend their model to the

nancial support of the Network on Mathematical Finance. The authors also wish to thank an anonymousault; Bruce D. Grundy; Soeren Hvidkjaer; Lasse Heje Pedersen; Ajai K. Singh; and participants at the EFA,sium on Market Microstructure and the International Conference on Finance for many helpful comments.

ll rights reserved.

136 K.L. Bechmann et al. / Journal of Corporate Finance 24 (2014) 135–148

announcement effects of the out-of-the-money calls, one extension is straightforward—investors can interpret the management'saction as a positive signal because the management is making an early repayment of the convertible bonds to avoid a later sharedilution for the existing shareholders.1

The second hypothesis is the price pressure effect that was first presented by Mazzeo andMoore (1992) and later expanded onby Bechmann (2004). The price pressure effect is the result of the equity trades by convertible bond holders as they adjust theirportfolio in anticipation of the call announcement. In the case of the in-the-money calls, the convertible arbitrageurs caneliminate the exposure to equity risk by short selling the stock while they wait for the conversion of their bonds. This short sellingresults in a negative reaction from the stock market as the price of the underlying stock falls. In the case of the out-of-the-moneycalls, the convertible arbitrageurs who buy the bonds and short the stock at the time of the debt offering can cover their shortposition as the matched bond position is closed (Duca et al., 2012). This buying results in a positive reaction from the stockmarket.

Distinguishing the signaling effect from the price pressure effect is difficult because both theories imply similar pricemovements in response to announcements. Not surprisingly, the literature has not reached a consensus, particularly on the maindeterminants of the negative announcement effect of the in-the-money calls (see, e.g., Bechmann, 2004; Brick et al., 2007; Dattaet al., 2003; Ederington and Goh, 2001; Grundy et al., 2014-in this issue). A potential difficulty in most of these studies is the focuson the long-run performance of the stock price subsequent to a call announcement. Given these challenges, Brick et al. (2007)conclude that the negative announcement effect for the in-the-money calls is still a puzzle that needs further examination.

Our aim is to shed light on this puzzle by taking two fundamentally new approaches to the analysis of convertible bond calls.First, we construct a large and unique data set that includes both the in- and the out-of-the-money calls. This data set allows us toexamine the stock market's reaction to both types of calls. Second, the data set includes the exact time of the call announcementas well as both trade and quote data. Thus, this high-frequency data set creates the opportunity to examine the stock market'sreaction in hours and minutes around the call announcement and to examine the direct link between the announcement effectand the various measures of price pressure. In doing so, we can more directly distinguish the signaling and the price pressureeffects and avoid the problems associated with a focus on long-run stock performance.

Our results suggest that the stock market's reaction to the in- and the out-of-the-money calls differs on several dimensions. Inparticular, we find that the stock market's reaction to the in-the-money calls is significantly related to several measures of pricepressure, such as the order imbalance as well as the fraction of seller-initiated trades. However, this is not the case for theout-of-the-money calls. Further, the stock market's reaction to the in-the-money calls is spread over an entire trading day afterthe announcement but the reaction to the out-of-the-money calls is much more immediate. We find that prices reach theirequilibrium point within less than half an hour after the out-of-the-money announcement. These and several other findingsprovide evidence that the price pressure effect is largely driving the stock market's reaction to the in-the-money calls but thesignaling effect is driving the stock market's reaction to the out-of-the-money calls.

This paper makes three main contributions to the literature on convertible bond calls. First, by providing evidence for the pricepressure effect of the in-the-money calls, we add clarity to the dominant forces at play in the market after the announcementtakes place. The importance of the price pressure effect also applies to other announcements such as mergers (see Mitchell et al.,2004), index revisions (see Elliot and Warr, 2003), or seasoned offerings (see Corwin, 2003). The second contribution is ourinsight into the positive reaction of the stock market to the out-of-the-money calls. The research in this area is relatively sparse.To the best of our knowledge, only one paper specifically examines out-of-the-money convertible bond calls (Cowan et al., 1993),and it uses a relatively limited sample. We also find a significant price response on the announcement day and extend the authors'research by showing that this response is related to the size of the call. In addition, we analyze the impact of the partial calls aswell as the source of the funding for the bond redemption. We find that the partial calls do not influence the announcement effectbut that the source of the funding is significant in explaining the effect. Further, we look for structural breaks in theannouncement effect for both types of bonds that is consistent with Duca et al. (2012) who find that convertible bondarbitrageurs are more prevalent after 2000. We do not find any evidence that suggests that the increased activity of theconvertible bond arbitrageurs alters the announcement effects for either type of call.

The rest of the paper is organized as follows: Section 2 contains a brief description of the convertible bond calls and the relatedliterature. Section 3 presents our method; and in Section 4, we define the data used in this paper. Section 5 presents our empiricalresults and Section 6 presents our conclusion.

2. Convertible bond calls

A convertible bond holder has an option to convert his or her bond into new common stock in the firm at any time. The optionmatures at the same time as the bond. Besides the conversion option, the majority of the convertible bonds also give the issuingfirm a call option that makes the premature redemption of the bonds possible. The firm redeems the bonds by sending a callannouncement to every bondholder that offers to buy their bonds for the call payment. The call payment (or the effective callprice) is the sum of the interest accrued since the last interest payment and the call price specified in the bond indenture. Theannouncement of the call starts the conversion period in which each bondholder still has the option to convert into stock. The call

1 Several out-of-the-money call announcements explicitly mention the ‘avoid-dilution argument’ as the main reason for the call. For example, on November 5,1997, BancTec Inc. made an out-of-the-money convertible bond call. In the call announcement, the firm said “the call will be funded with internal capital andexisting lines of credit and should allow the company to avoid dilution of 1.5 million shares,” which should be compared to the 21.1 million shares outstanding.

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announcement states the deadline for the conversion as well as the call date (redemption date) when the unconverted bonds areredeemed and the corresponding call payments are made.

The in-the-money calls aim at forcing a conversion. These calls have a conversion value that is higher than the call payment atthe time of the call. Therefore, the firm expects that the bondholder will prefer a conversion into stock at the end of theconversion period. For the out-of-the-money calls, the conversion value is less than the call payment, and hence the bondholderwill prefer the call payment.

2.1. In-the-money calls

The negative announcement effect of the in-the-money calls was first documented by Mikkelson (1981). To explain theresulting decline in equity prices, Harris and Raviv (1985) provide a signaling model where the call represents bad news about thecalling firm's prospects. By calling the convertible bonds, the management forces the conversion into the overpriced equity. Themanagers with positive private information should optimally choose not to force a call and instead choose to delay the call, thuskeeping the conversion option alive. Ofer and Natarajan (1987) and Datta et al. (2003) find negative long-run abnormal returnsand use these returns as evidence for the bad-news explanation or signaling hypothesis.

On the other hand, Mazzeo and Moore (1992) find a recovery in stock prices during the conversion period and argue that theannouncement effect is because of the price pressure caused by the investors that want to sell the new shares received onconversion. However, a problem with this explanation is that the bonds are generally not converted at the time of the callannouncement because of the American-type conversion option. Therefore, the new shares are not issued until later. Thus,Mazzeo and Moore (1992) are missing an explanation as to how the later increase in the supply of shares is actually translatedinto the price pressure at the time of the call announcement.

Bechmann (2004) provides the missing explanation with evidence that the price pressure is caused by short selling. Two typesof investors have an incentive to hedge their equity exposure by short selling at the time of the call. First, the convertiblearbitrageurs try to lock in arbitrage profits by buying the called convertible bond and short selling the underlying stock. This shortselling is used to hedge the equity risk of the convertible bond because the conversion option is not exercised immediately.Second, a possible underwriter of the call also short sells in order to hedge the equity risk associated with the call. The shortselling of stock by these two types of investors, at least in part, causes short-term price pressure because the price must fall toinduce investors to absorb the increased supply of shares in accordance with the cost of liquidity.

Brick et al. (2007) test the price pressure effect by examining whether the stock prices recover during the conversion period,and whether the announcement effect is related to proxies for the stock's liquidity. The results are not supportive of the pricepressure explanation. However, they also add a test for the signaling effect, and the results are also inconclusive. Hence, theirconclusion is that the negative announcement effect is still a puzzle and needs further examination.

Grundy et al. (2014-in this issue) find evidence in favor of the price pressure effect in two separate empirical specifications.First, they find that the calls of dividend-protected convertible bonds, which arguably are predictable, also lead to a significantlynegative announcement effect. Second, and also consistent with a price pressure effect, they find that the size of theannouncement effect is inversely related to the involvement of the convertible arbitrageurs prior to the announcement.

2.2. Out-of-the-money calls

To our knowledge, the research of Cowan et al. (1993) provides the only published paper that examines the announcement ofthe out-of-the-money calls. Using a data set of just 26 observations, they find a positive and significant announcement effect andexplain this finding as being primarily because of the positive news disclosed by the call. Cowan et al. (1993) suggest thefollowing reasons for an out-of-the-money call being positive news. First, the firm-initiated call shows that the firm has access toor is able to raise enough cash to redeem the bonds. Second, the firm might call the debt to get rid of some restrictive covenantsattached to the bond issue, an explanation suggested by Vu (1986) for calls of non-convertible debt. Third, the call might bepositive news because the firm is simply financing the call by using, for example, a new convertible bond issued at a lower cost.

2.3. Optimal convertible bond call policy

While our goal is to examine the price response of the equity market to convertible bonds calls, the market's anticipation ofsuch calls is also important to consider. There is a great deal of literature that examines the firm's optimal call policy. Most of thepapers agree with the perfect market's decision rule in Ingersoll (1977) that the optimal choice is to call the convertible bonds assoon as their conversion value exceeds the effective call price. However, the empirical evidence is inconsistent with thistheoretical model.

An alternative explanation that is consistent with the empirical evidence focuses on the difference between the after-taxcoupon payments of the convertible bond and the dividends to be paid on conversion (Asquith and Mullins, 1991). Sarkar (2003)extends this explanation by taking into account the possibility of default prior to maturity. In particular, Sarkar (2003) predictsthat calls are associated with coupons, call premiums, dividend income, volatility, taxes, and interest rates. His empirical study of45 out-of-the-money and 136 in-the-money calls supports these predictions.

In a recent paper, King and Mauer (2014-this issue) focus on the in-the-money calls and find that the firms only call when thecall provides a cash flow advantage and the conversion option is sufficiently deep in-the-money to avoid a failed call. Inconsistent

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with the signaling hypothesis, there is no evidence that firms with positive information are more likely to delay calls. They alsoexamine out-of-the-money calls. However, these calls are for the most part “event driven calls” in which rating changes orchanges in the interest rate provide the firm with an incentive to call. Therefore, they are not generally anticipated by the market.

2.4. Convertible bond arbitrage

The convertible bond arbitrageurs (hedge funds) play an important role in the convertible bond market (see, e.g., Brown et al.,2012; Loncarski et al., 2009). Choi et al. (2010) show that the convertible arbitrageurs are important providers of financingthrough their demand for convertible bonds. Duca et al. (2012) show that the increased involvement of the convertiblearbitrageurs can explain an increase in the negative announcement effect around the issuance of the convertible bonds whencomparing the period of 1984 to 1999 with 2000 to 2008. Similarly, De Jong et al. (2011) find that many issuances of convertiblebonds are combined with a stock repurchase to facilitate the convertible bond arbitrage. Finally, Choi et al. (2009) find a largeincrease in short selling at the issuance of convertible bonds and relate that to convertible bond arbitrage.2

3. Methodology

In this section, we describe our method of analyzing both the daily and the intraday returns. In addition, we also describe thevarious price pressure proxies used in the paper.

3.1. Daily event study

To confirm the pattern in the stock market's reactions to call announcements, we conduct an event study. In conventionalevent studies, returns are aligned in event time such that the announcement of the call happens at day 0. The announcementeffect for firm i is then calculated as the sum of the market adjusted returns for (at least) day 0 and day 1 (see, e.g., the overview ofcall announcement studies in Grundy et al., 2014-in this issue). The lack of data on the exact announcement time is the standardreason for including both day 0 and day 1 returns. If the call happens after the market closes on day 0, the stock market's reactioncan only be seen at day 1.3 One advantage of our data set is that we have the exact announcement time. This knowledge allows usto examine the announcement effect more precisely. For example, we adjust the announcement date for calls that happen afterthe market closes, which reduces the possible impact of other contaminating news.

Following the literature on intraday studies, we first focus our analysis on the raw returns. Although a simple marketadjustment is used for general market movements, we only estimate the announcement effects over a maximum of one day.Because the daily expected returns are close to zero, such an adjustment is less important (see, e.g., Busse and Green, 2002; Fama,1997).4 Our event study regression analysis uses day 0 returns, ri(0), to examine the speed and the influence of the price pressureproxies on the observed announcement effect for both the in- and the out-of-the-money calls. Formally the model is asfollows:

2 Deconvert

3 Forannoun

4 Theso closechalleng

ri 0ð Þ ¼ cþ a′1Y1;i þ a′2Y2;i þ d′PPi ð1ÞY1,i is the vector of firm i specific controls, and Y2,i is the vector of convertible bond controls. The objective of this model is

where

to estimate the impact of the price pressure proxies, PPi, on the market's reaction to the call announcement after controlling forother factors that could affect the response. The coefficient of primary interest is d, which should be statistically significant if theprice pressure influences the market's response.

3.2. Intra-day event study

We take two different empirical approaches in our analysis of the intraday data. First, as in Patell and Wolfson (1984), wedivide the event window into half hour intervals to closely examine the speed with which the stock market reacts to theannouncement. Our calculation of the returns is based on the mid-quotes extracted from the NYSE's Trade and Quote (TAQ)database as close as possible to the end of these intervals. To address shorter time periods, as in Busse and Green (2002), wereestimate our results over five- and fifteen-minute intervals, and the conclusions remain unchanged.

To estimate the p-values, we follow Busse and Green (2002) and implement the nonparametric bootstrapped algorithm inBarclay and Litzenberger (1988). This algorithm produces an empirical bootstrapped p-value for a one-sided hypothesis test anddoes not assume that the returns are normally distributed. To construct these p-values, the null hypothesis is defined as the

Jong et al. (2012) show that short-sale constraints across 35 countries are important in explaining the stock price pattern around the issuance ofible bonds that is consistent with the effect of the convertible bond arbitrage.event studies of announcements found in, for example, The Wall Street Journal, days−1 and 0 are used as event days with day 0 being the date where thecement appears in The Wall Street Journal.fact that it is not necessary to decide on a method for calculating the market adjusted returns is another advantage of examining the announcement effectly around the announcement. As discussed in Brick et al. (2007) the choice of the market adjustment and the associated estimation period is clearly ae (see also Campbell et al., 1991; Cowan et al., 1990).

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expected return being greater than or equal to zero for the in-the-money calls and the expected return being less than zero for theout-of-the-money calls. As a robustness check, we also use the technique in Barclay and Litzenberger (1988) to construct atwo-sided bootstrap test based on the so-called ‘percentile-t’ method (see Cameron and Trivedi, 2005). We then reestimate thecross-sectional regression result using the intraday data.

3.3. Price pressure measures

To directly examine the price pressure proxies, we use the TAQ database and develop estimates of the order imbalance and thefraction of seller-initiated trading. Several steps are involved in the construction of these variables. The first is the use of the filterrules in Chordia et al. (2001) to eliminate any possible recording errors in the TAQ data. Next, the trades are identified as buyer- orseller-initiated trades by comparing the transaction price to the prevailing primary market bid and ask quotes. Using thealgorithm in Lee and Ready (1991), the transactions below the mid-quote are classified as seller-initiated trades while the tradesabove the mid-quote are classified as buyer-initiated trades.5 In the case where the transaction price is at the mid-quote, weexamine the price change of the previous trade. If the previous trade price is higher (lower) than the trade that preceded it, thenthe trade is classified as a buy (sell). We apply this tick test up to the past five transactions. If the previous five transactions do nothave a price change, then the trade is not classified.

The third step is to compute the following measure of the order imbalance over the half hour intervals:

5 Confindings

6 Thesome m

7 Fordone byparagra

8 Exaprogram

IMBALSH ¼ Number of shares bought−Number of shares soldTotal number of shares traded

: ð2Þ

The IMBAL_SHmeasures the percentage of order imbalances by trade volume that gives the larger trades more weight than thesmaller trades. This is our primary measure of the order imbalance because it should give the convertible bond arbitrageursgreater weight over the smaller investors. We also develop another measure of the order imbalance based on the number oftrades:

IMBALNUM ¼ Number of buy trades−Number of sell tradesTotal number of trades

: ð3Þ

Further, we also calculate the percentage of seller-initiated trades in terms of their volume. These measures are used asrobustness checks of the primary order imbalance measure.

4. Data

The data set consists of the convertible bond calls during the period of January 1993 to December 2007 that we identifiedthrough a range of newswires, search engines, and lists of calls. From these sources, a call data set is constructed withobservations fulfilling all of the following selection criteria: (1) the announcement date and time could be identified from thenewswires.6 (2) The information about the firm's stock is available in the CRSP and TAQ databases (the underlying shares aretraded on the NYSE, AMEX, or NASDAQ). (3) Sufficient details regarding the called convertible bond could be identified fromvarious bond guides, from the call announcement itself, or from Bloomberg. (4) The announcement is not contaminated by othernews in the sense that there is no other news announced about the firm in the call announcement.7 (5) The convertible bond isonly convertible into the common stock of the calling firm. Criteria 1, 2, 3, and 5 are similar to those used in other event studies onconvertible bond calls (see, e.g., Bechmann, 2004; Brick et al., 2007; Cowan et al., 1993; Datta et al., 2003). Given our rich data set,we are also able to add criterion 4 and to screen for the contamination by other news. By reading the actual announcements wefind some instances where the call was most likely not the main source of news in the announcement.8 Thus, criterion 4 providesa cleaner estimate of the announcement effects relative to other studies. To test the sensitivity of this criterion, we also estimateour results by adding our identified contaminated call announcements and our main conclusions hold.

For our final data set of calls, our selection criteria lead to a sample of 554 calls with 364 being in-the-money calls and 190 beingout-of-the-money calls. The calls are fairly evenly distributed over the time period under study as illustrated in Table 1. However, theyears 2002 and 2003 had relatively more out-of-the-money calls; this finding might be because of the decrease in stock prices(preventing in-the-money calls) and a decrease in the interest rates (promoting refinancing by using out-of-the-money calls).

sistent with Lee and Ready (1991), we match the quotes with trades using a five-second delay. We follow this five-second delay until 1998. Based on theof Madhavan et al. (2002) and Chordia et al. (2001), we do not impose any delays in matching the trade and quote data after 1998.announcement time is the first time at which the news can be found in any of the newswires. However, the news might have been released from the firminutes earlier.announcements made outside market hours, we also exclude firms where other news is released before the market opens. The screening for other news issearching in the newswires for other articles about the firm and excluding the observations where the firm is mentioned in the headline or in the lead

ph.mples include cases where the annual or quarterly accounting report was realized in the same announcement or where the new share repurchases, changes in dividends, or mergers and acquisitions were announced together with the call.

Table 1The distribution across years of the sample of convertible bond calls for the in-the-money (ITM) and the out-of-the-money (OTM) calls. ‘Percent ITM’ is thepercent of all calls that are in-the-money.

Year 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Total

ITM 28 26 26 50 30 25 24 23 25 12 14 29 24 20 8 364OTM 10 11 12 15 19 3 5 2 4 13 47 25 10 10 4 190Total 38 37 38 65 49 28 29 25 29 25 61 54 34 30 12 554Percent ITM 74% 70% 68% 77% 61% 89% 83% 92% 86% 48% 23% 54% 71% 67% 67% 66%

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4.1. Summary statistics

Table 2 shows the basic summary statistics for the data set that lead to some relevant findings for our study. First, both types ofcalls are generally quite large in the sense that the conversion of the called convertible bonds, on average, increases the number ofshares outstanding by 10.57% for the in-the-money calls and 7.63% for the out-of-the-money calls. While the out-of-the-moneycalls are not expected to be converted into equity, this data is provided as a benchmark. Similarly, as a fraction of the total value ofequity, the total call payment corresponds to 7.27% for the in-the-money calls and 12.53% for the out-of-the money calls.

The minimum values for both of the variables indicate the presence of clean-up and/or partial calls in our sample. The clean-upcalls are designed to redeem a small issue to avoid servicing a small amount of outstanding debt; the partial calls only redeema fraction of the outstanding debt. Based on an in-depth analysis of the call announcements, we identify 34 (9%) of the

Table 2The descriptive statistics for the convertible bond calls.

Mean Median Minimum Maximum

In-the-money callsIncrease in number of shares (millions) 6.12 3.78 0.06 55.30Increase in number of shares (%) 10.57% 8.05% 0.01% 65.21%Value of equity ($ millions) 5435 1499 22 141,810Daily turnover (%) 0.95% 0.69% 0.00% 7.80%Size of called issue ($ millions) 133 81 1 1260Total call payment/value of equity (%) 7.27% 5.58% 0.00% 51.71%Conversion value/call payment 1.70 1.36 1.00 11.03Length of conversion period (calendar days) 33 31 6 135Number of years to maturity 7.71 6.00 0.00 29.00Stock exchange NYSE AMEX NASDAQFraction 62% 6% 32%Announcement time (group) Morning (I) Day (II) Evening (III)Fraction 31% 34% 35%

Out-of-the-money callsIncrease in number of shares (millions) 6.20 3.35 0.10 137.54Increase in number of shares (%) 7.63% 4.89% 0.00% 43.83%Value of equity ($ millions) 4904 1247 35 145,840Daily turnover (%) 0.95% 0.58% 0.07% 6.29%Size of called issue ($ millions) 208 109 5 2000Total call payment/value of equity (%) 12.53% 8.07% 0.03% 67.12%Conversion value/call payment 0.66 0.76 0.01 0.99Length of conversion period (calendar days) 33 31 9 150Number of years to maturity 6.72 4 0 28Stock exchange NYSE AMEX NASDAQFraction 61% 6% 34%Announcement time (group) Morning (I) Day (II) Evening (III)Fraction 37% 36% 27%

The increase in the number of shares (millions) is defined as the total number of new shares that can be issued on a full conversion of the bonds called. Theincrease in the number of shares (%) is obtained by dividing the shares' increase (millions) by the number of shares outstanding before the call. The value ofequity ($ millions) is the total market value of the firm's equity. The daily turnover (%) is calculated as the number of shares traded during a day divided by thenumber of shares outstanding and is based on the period from 180 days before to 180 days after the announcement but excluding the period from five daysbefore the announcement to five days after the end of the conversion period. The size of called issue ($ millions) is the face value of the debt outstanding beforethe call. The total call payment/value of equity (%) is the total amount of money that should be paid to redeem the bonds for cash divided by the total value ofequity before the call. The conversion value/call payment measures the extent to which the conversion option is in-the-money. The conversion value and thevalue of equity are calculated based on the stock price two days prior to the announcement of the call. The length of the conversion period (calendar days) is thenumber of calendar days from the announcement of the call until the end of the conversion period. The number of years to maturity is the number of years fromthe time of the call until the maturity of the bond. The stock exchange fraction is the distribution of the calls across the different stock exchanges. The time ofannouncement fraction is the distribution of the calls across different announcement times, where Group I is calls announced before opening of the market, GroupII is calls announced during market hours, and Group III is calls announced after the market is closed.

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in-the-money calls as partial and 26 (14%) of the out-of-the-money calls as partial. In addition, we also find that 103 (54%) of theout-of-the-money calls self-identify how the redemption is financed.

Table 2 also presents the summary statistics for turnovers, conversion periods, years to maturity, and distributions acrossexchanges by type of call. For stock turnover rates, we find that there is no difference when looking at the mean; however, theequity of the firms making the in-the-money calls tends to be more actively traded. Apart from these differences, the two types ofcalls are similar with respect to the length of the conversion period, the number of years left to maturity, and the distributionbetween different stock exchanges. These descriptive results are in line with those of other studies on convertible bond calls.9

Table 2 also displays the distribution of the announcement time. Group I consists of the observations where the announcementis made before the market opens (before 9:30 AM), Group II comprises the observations with an announcement made duringmarket hours, and Group III comprises the observations where the announcement is made after the market closes (after4:00 PM). For the in-the-money calls, the distribution is spread evenly across the three groups with 31% in Group I, 34% for GroupII, and 35% in Group III. For the out-of-the-money calls, the numbers are 37% for Group I, 36% for Group II, and 27% in Group III.While the majority of both types of calls are announced outside the stock market's hours, these results suggest that thein-the-money calls are slightly more likely to be made after the market closes and the out-of-the-money calls are likely to bemade before the market opens.10

5. The announcement effect

In this section, we analyze the announcement effect for the in- and out-of-the-money convertible bond calls. Table 3 showsthe results of the daily event study. Consistent with the literature, we find a highly significant and negative announcement effectfor the in-the-money calls and a significant and positive announcement effect for the out-of-the-money calls. These stylized factsare confirmed by our analysis on both the raw returns and the market adjusted returns.11

5.1. Cross-sectional study of the daily announcement effect

The univariate statistics presented in Table 3 indicate that the call announcements are associated with a significant reactionfrom the stock market. Along the lines of Cowan et al. (1993), Bechmann (2004), and Grundy et al. (2014-in this issue), weexamine the determinants of the stock market's reactions by running a cross-sectional regression with our one-dayannouncement effect as the dependent variable. Our primary variables of interest are the order imbalance by trade volume(IMBAL _ SH) and the size of the call (SIZE). The IMBAL _ SH is designed to capture the price pressure that results from the unequaltrading activity following the call announcement. As shown in Bechmann (2004), SIZE is also related to the price pressure.However, in the absence of the price pressure, the SIZE is also expected to be related to the signaling effect. The larger the size ofthe announcement the stronger the signal provided to outside investors. Further, we also add the physical probability that theconversion option will end out-of-the-money.12 King and Mauer (2014-this issue) find that the risk of a failed call is relevant inexplaining the firm's call policy, and hence, this probability should help explain the stock market reaction according to thesignaling effect.

Table 4 presents ourmain results on the determinants of the announcement effect. For the in-the-money calls, the announcementeffect is significantly related to the IMBAL _ SH in all of the specifications but this is never the case for the out-of-the-money calls.Consistent with the signaling effect, the out-of-the-money calls are significantly related to the size of the call.13

In all of the cases, the probability that the conversion option ends out-of-the-money is insignificant. As an alternative to thisprobability, we have also included the moneyness of the conversion option defined as the conversion value divided by the callpayment, but contrary to Bechmann (2004) moneyness is also insignificant in all regressions.14 These findings suggest that theIMBAL _ SH is a better proxy for explaining the price pressure in the announcement effect of the in-the-money calls than theprobability that the conversion option ends out-of-the-money and the moneyness.

9 Convertible bonds with cash settlement features have become more common as documented by Lewis and Verwijmeren (2014-this issue) because offavorable accounting treatment in the period from 2002 to 2008. It would be interesting to examine the announcement effect for in-the-money calls ofconvertible bonds with cash settlement features given that these calls do not necessarily result in an increase in the number of shares outstanding. However,when comparing our sample with the sample of Lewis and Verwijmeren (2014-this issue), we find that our sample only includes a relatively small number ofcash settlements. We wish to thank Lewis and Verwijmeren for sharing their sample and believe this is a promising area for further research.10 Summary statistics for the groups with different announcement times are also examined, and these provide evidence of the homogeneity of these groups.11 It should also be mentioned that we examine the stock returns in the days before and after our announcement day 0. These returns are in all casesinsignificant that suggests the appropriateness of our approach of only looking at the one-day announcement effect.12 We estimate the physical probability of conversion in the spirit of Lewis and Verwijmeren (2011). Given that the conversion option in the case of a call issimpler and has much shorter time to maturity (the length of the conversion period), we calculate the physical probability using the results of Rubinstein (1976,formula A.1) instead of the Monte Carlo approach. Given the short time to maturity, it is found that the estimated stock price volatility is more important than theestimated expected stock return. Therefore, we deviate from the approach in Lewis and Verwijmeren (2011) and estimate the volatility based on stock returnsduring the last year before the call, and for robustness we also estimate volatility during the last six months before the call and during the conversion period (seeBechmann, 2004).13 As in Cowan et al. (1993), we have used the total call payment relative to the market value of equity as our size measure. However, because the out-of-the-money calls in many cases are made in order to avoid dilution, one could argue that the number of new shares that could be issued on conversion divided by thenumber of shares outstanding also is a relevant size measure. We use this size measure in all of the regressions, and it is significant at the 1% level and the otherresults are unchanged.14 These results are available upon request.

Table 3The one-day announcement effect.

In-the-money Out-of-the-money

Raw returnMean −1.57%*** 1.88%***Median −1.17%*** 1.56%***% negative 72%*** 19%***

Market adjustedMean −1.53%*** 1.66%***Median −1.14%*** 1.25%***% negative 72%*** 22%***

The table shows the one-day announcement effect and the two different tests for the significance of the stock returns—a standard Z-test and a nonparametric signtest. The announcement effect is calculated based on the closing prices for the announcement date for the calls announced before the market opens (Group I) andfor the calls announced during market hours (Group II) but the following day for calls announced after the market closes (Group III). The ITM refers to thein-the-money calls and the OTM to the out-of-the-money calls. The ⁎⁎⁎, ⁎⁎, and ⁎ denote significance at the 1%, 5%, and 10% levels respectively.

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Given the large cross-sectional variation in the characteristics of the convertible bonds, we present the results from both anOLS test and an outlier-robust (Holland andWelsch, 1977) regression in Table 4. The results from the two regressions techniquesare generally consistent.

We also consider a possible structural break after 2000 to address the finding of Duca et al. (2012). Their research suggests thatinvestors changed from traditional long-term investors during 1984 to 1999 to convertible bond arbitrageurs in the period of2000 to 2008. For both the in- and the out-of-the-money calls, we add a dummy for calls that were announced in the period from2000 to 2007 and an interaction with IMBAL _ SH. In the case of the in-the-money calls, the dummy variable provides weakevidence that the announcement effect is smaller in this later period compared to the earlier period. However, the interactionshows that the significant relation between the announcement effect and the price pressure proxy remains unchanged in theperiod from 2000 to 2007. We conclude that the increased activity by the convertible bond arbitrageurs in the period after 2000results in a slightly smaller announcement effect but a negative announcement effect still remains that is significantly related to

Table 4The OLS and outlier-robust regression model for the announcement effects.

OLS results

Model A Model B

ITM OTM ITM OTM

Intercept −0.0162*** 0.0169 −0.0180*** 0.0223IMBAL_SH 0.0119** −0.0016 0.0107** 0.0023SIZE −0.0184 0.0624*** −0.0208 0.0647***Probability of no conversion 0.0116 −0.0049 0.0161 −0.0092Market Fixed Effects No No Yes YesIndustry Fixed Effects No No Yes YesYear Fixed Effects No No Yes YesNumber of observations 364 190 364 190Adj. R2 0.0238 0.0643 0.1270 0.1652

Robust Results

Model A Model B

ITM OTM ITM OTM

Intercept −0.0102*** 0.0169 −0.0143** 0.0236IMBAL_SH 0.0075** −0.0014 0.0084** 0.0018SIZE −0.0305* 0.0660*** −0.0255 0.0664***Probability of no conversion 0.0018 −0.0078 0.0070 −0.0110Market Fixed Effects No No Yes YesIndustry Fixed Effects No No Yes YesYear Fixed Effects No No Yes YesNumber of observations 364 190 364 190

Results from a standard OLS and an outlier-robust regression technique (Holland and Welsch, 1977) with our one-day announcement effect as the dependentvariable. The ITM refers to the in-the-money calls and the OTM to the out-of-the-money calls. The IMBAL_SH is the order imbalances normalized by total volumeover the announcement day, the SIZE for the ITM is the number of new shares to be issued on conversion divided by the number of shares outstanding before thecall, the SIZE for the OTM is the aggregate call payment divided by the total market value of the equity before the call, and the Probability of no conversion is thephysical probability that the conversion option will end out-of-the-money at the end of the conversion period. The Market Fixed Effects, Industry Fixed Effects,and Year Fixed Effects control for differences between stock exchanges, industries, and across years. The ⁎⁎⁎, ⁎⁎, ⁎ and denote significance at the 1%, 5%, and the10% levels respectively.

143K.L. Bechmann et al. / Journal of Corporate Finance 24 (2014) 135–148

our proxy for the price pressure. In the case of the out-of-the-money calls, there is no evidence of a structural break in our resultsfor the period of 2000 to 2007.

For our out-of-the money call regressions, the only significant variable is the call size. This is consistent with the signalingeffect. To further examine this result, we consider the possibility that the method of financing the redemption affects the stockmarket's reaction (see Cowan et al., 1993). We examine the call announcement and the associated firm's earlier announcementsfor information regarding the source of the cash used for the redemption. In many cases, the call announcement was preceded bysignificant issuances of financial securities where the call was listed as one of the possible uses of the cash raised. In these casesthe call announcement effect might be tempered as the market already anticipates the call. In total, 103 out of the 190 firms without-of-the-money calls self-report the source of the cash used in the redemption. We then divide these firms into the followinggroups 15:

Group 1: cash obtained from an earlier issuance of financial securities, often but not always convertible bonds (44observations)Group 2: cash obtained from existing lines of credit or short-term credit facilities (13 observations)Group 3: existing cash (many of these also mention the avoid dilution argument) (46 observations).

Table 5 provides the results that allow for the differences in the source of financing. These specifications also allow for thepossibility of partial calls and are included along the control variables. This latter variable is insignificant in all cases and does notshow a relation between the positive announcement effect and a reduction in the restrictive covenants as suggested in earlierstudies (see Cowan et al., 1993; Vu, 1986). The former set of variables – those controlling for the source of financing – imply ahigher announcement effect for the out-of-the-money calls if the firm uses cash from existing lines of credit or existing cash tofinance the redemption. This is consistent with such announcements being less anticipated and hence supports the signalingeffect for the out-of-the-money calls.

5.1.1. RobustnessWe conduct a number of robustness checks, and our results remain unchanged after adding alternative proxies and controls.

First, we use other proxies for the price pressure that include the IMBAL _ NUM and the proportion of seller-initiated trades bothin terms of volume and the number of trades. Consistent with the effect of the IMBAL _ SH, these price pressure proxies have asignificant (at the 5% level) and positive relation to the announcement effect for the in-the-money calls but are insignificant forthe out-of-the-money calls. Second, we add other characteristics of the calls. For example, earlier studies use the length of theconversion period and the return volatility of the stock to control for a wider range of market determinants (see, e.g., Bechmann,2004; Grundy et al., 2014-in this issue). Consistent with these studies, we find that these variables are generally insignificant inexplaining the announcement effect for both the in- and the out-of-the-money calls. Finally, we also add controls for the effect ofthe general liquidity of the stock (see Brick et al., 2007) by including the relative quoted spread as well as the relative effectivespread. These liquidity variables are generally insignificant, and our results remain unchanged.

5.2. The speed of the stock market's reaction

Our second set of results examines the speed of the stock market's reaction in half hour intervals to pick up the possible signalingeffect of the call announcement. This analysis examines the mean returns around the time of the announcement. While these meanreturns are relatively noisy, as shown in Table 6, the cumulative returns are consistent with the earlier daily results. The cumulativereturn that follows the trading up to 14 h after the announcement is negative for the in-the-money calls (−1.56%) andpositive for theout-of-the-money calls (1.78%). These results are not surprising and confirm our earlier results and those in the literature.

We also find evidence of an announcement effect or an immediate response to the disclosure of the call decisions. Both typesof calls have a statistically significant price reaction in the half hour immediately following the announcement. In the case of thein-the-money calls, the immediate price response is −0.70% that corresponds to approximately 45% of the cumulative returns.For the out-of-the-money calls, the immediate price response is 1.37% or over 76% of the aggregate responses. Both of theseimmediate price responses are statistically significant at the 1% level using the p-values from the empirical bootstrap. Insubsequent half hour intervals, the price continues to decline for the in-the-money calls. In many cases, the negative decline issignificant at the 1% to 5% levels. For the out-of-the-money calls, the returns over the ensuing half-hour intervals are muchsmaller and generally insignificant.

To allow for misinformation, leakage of information, and a falsification test, we also examine the five half hour intervals priorto the announcement. We find a lack of a strong preannouncement price response that suggests we have accurately identified thetime of the announcements. There is a small price response in the half hour interval before the announcement for thein-the-money calls. This effect is −0.08% and, while significant at the 5% level, is relatively minor.16

15 In cases where several sources of financing are listed, we can often identify the main source from the information. For example, if the firms finance theredemption by using cash and a new debt issuance, and the new issue is very large relative to the bond being called; then we classify this redemption as beingrefinanced with new debt. In cases, where several sources are mentioned and it is not possible to identify their relative importance, we classify them as missingobservations.16 It should also be mentioned that such “leakage” is also found, for example, by Masulis and Shivakumar (2002) for announcements of seasoned equityofferings and by Patell and Wolfson (1984) for dividend and earnings announcements.

Table 5The OLS and outlier-robust regression model for the out-of-the-money announcement effects examining sources of financing.

OLS results Robust results

Model A Model B Model A Model B

OTM OTM OTM OTM

Intercept −0.0049 0.0128 −0.0071 0.0184IMBAL_SH 0.0080 0.0060 0.0049 0.0032SIZE 0.0709** 0.0528* 0.0861*** 0.0488*Probability of no conversion 0.0019 0.0045 0.0031 −0.0019Partial 0.0050 0.0064 0.0040 0.0067Financing Group 2 0.0214** 0.0129 0.0245*** 0.0138Financing Group 3 0.0306*** 0.0274*** 0.0251*** 0.0252***Market Fixed Effects No Yes No YesIndustry Fixed Effects No Yes No YesYear Fixed Effects No Yes No YesNumber of observations 103 103 103 103Adj. R2 0.2508 0.4395

The results from a standard OLS and an outlier-robust regression technique (Holland andWelsch, 1977) with our one-day announcement effect as the dependentvariable for the out-of-the-money calls (OTM). The IMBAL_SH is the order imbalances normalized by total volume over the announcement day, SIZE is theaggregate call payment divided by the total market value of the equity before the call, and the Probability of no conversion is the physical probability that theconversion option will end out-of-the-money at the end of the conversion period. The Financing Group 1–3 refers to the different sources of financing that thefirm announces will be used to finance the redemption, where Financing Group 1 is used as the benchmark group. The Market Fixed Effects, Industry Fixed Effects,and Year Fixed Effects control for differences between stock exchanges, industries, and across years. The ⁎⁎⁎, ⁎⁎, ⁎ and denote significance at the 1%, 5%, and the10% levels respectively.

Table 6The speed of the price adjustment to the call announcements.

Time relative toannouncement

ITM OTM

Mean return Returns b0 relativeto non-zero returns

Cumulativereturn

Mean return Returns b0 relativeto non-zero returns

Cumulativereturn

−2.30: −2.00 −0.04% 53% −0.04% 0.02% 46% 0.02%−2.00: −1.30 0.09%** 56%** −0.13% 0.04% 52% 0.05%−1.30: −1.00 0.01% 48% −0.11% 0.05% 48% 0.10%−1.00: −0.30 −0.04% 49% −0.16% 0.01% 43%* 0.11%−0.30: −0.00 −0.08%** 55%** −0.24% 0.07% 45% 0.18%

0.00: 0:30 0.70%*** 70%*** −0.93% 1.37%*** 21%*** 1.55%0.30: 1:00 0.18%*** 59%*** −1.11% 0.04% 49% 1.59%1.00: 1:30 −0.05% 51% −1.17% 0.09%* 50% 1.69%1.30: 2:00 0.09%** 54%* −1.25% −0.01% 46% 1.68%2.00: 2:30 −0.04% 60%*** −1.29% 0.02% 51% 1.70%2.30: 3:00 −0.02% 52% −1.32% 0.00% 49% 1.70%3.00: 3:30 −0.06%** 53% −1.38% 0.03% 44%* 1.73%3.30: 4:00 0.01% 51% −1.37% 0.04% 44%* 1.76%4.00: 4:30 −0.06%** 55%** −1.43% 0.00% 50% 1.77%4.30: 5:00 −0.03% 57%** −1.46% −0.03% 56%* 1.74%5.00: 5:30 −0.06%* 54%* −1.52% 0.02% 54% 1.76%5.30: 6:00 −0.03% 52% −1.55% −0.03% 51% 1.73%6.00: 6:30 −0.03% 53% −1.58% −0.03% 53% 1.70%6.30: 7:00 −0.01% 48% −1.59% 0.16%** 44%* 1.86%7.00: 8:30 −0.02% 49% −1.61% −0.05% 49% 1.81%8.30: 9:00 0.05% 53% −1.56% 0.05% 50% 1.86%9.00: 9:30 −0.04% 53% −1.60% 0.01% 46% 1.87%9.30: 10:00 −0.02% 52% −1.62% −0.05% 52% 1.82%

10.00: 10:30 −0.05% 50% −1.67% −0.04% 51% 1.77%10.30: 11:00 0.05% 49% −1.62% 0.03% 48% 1.80%11.00: 11:30 0.00% 51% −1.63% 0.00% 52% 1.80%11.30: 12:00 0.02% 48% −1.61% 0.00% 48% 1.80%12.00: 12:30 0.07% 48% −1.53% 0.05%* 51% 1.84%12.30: 13:00 −0.02% 54%* −1.55% −0.09%*** 60%*** 1.75%13.00: 13:30 0.03% 49% −1.52% 0.04% 49% 1.79%13.30: 14:00 −0.04% 54%* −1.56% −0.01% 48% 1.78%

The returns in half hour intervals relative to the announcement time. The returns are calculated based on the quoted prices as close as possible to the end of eachhalf hour period. The test for the significance of the return in the individual event periods is calculated based on the bootstrapped p-value whereas anonparametric t-test is used to test if the fraction of the negative returns is different from the fraction of the positive returns. The ⁎⁎⁎, ⁎⁎, and ⁎ denote significanceat the 1%, 5%, and the 10% levels respectively. The ITM is the in-the-money calls, and OTM is the out-of-the-money calls.

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Overall, similar conclusions can be reached by examining the fraction of negative returns over the same half hour intervalsafter the announcement. The majority of the in-the-money calls show negative returns at the time of the announcement andcontinue to show negative returns over the next 5 to 6 h. But, for the out-of-the-money calls, the majority of the returns arepositive at the time of announcement after which there is no clear direction. The statistical significance of these results isestablished using a nonparametric t-test.

Figs. 1 and 2 show the graphical depictions of the average cumulative returns for both types of calls. The figures both use the14 half hour intervals before the announcement and the 28 half hour intervals after the announcement. These intervalscorrespond to a period from one trading day before to two trading days after the announcement. Several interesting observationsfollow from Figs. 1 and 2. First, there is a negative reaction to the in-the-money calls and a positive reaction to theout-of-the-money calls, and the reactions appear to be caused by the announcements. However, there is some evidence of apreannouncement reaction in the period before the announcement as the average cumulative returns start drifting downwardsfor the in-the-money calls and upwards for the out-of-the-money calls. This evidence suggests that the timing of theannouncements might be anticipated. Second, the announcements of the out-of-the-money calls immediately lead to a strongreaction from the stock market. Most of this announcement effect is an increase in the stock price in the event period 0, that is, theperiod ending shortly after the announcement time. Furthermore, from half an hour after the announcement and onwards, thereis only weak evidence of a positive drift in the average cumulative returns.

The stock market's reaction to an in-the-money call is not nearly as immediate. For example, the stock-price reaction in eventperiods 0 and 1 is quite small and the average cumulative returns continue to drift downwards until 6 or 7 h after theannouncement, that is, a whole trading day after the announcement. Thereby, Fig. 1 suggests that the stock market's reaction tothe in-the-money calls is slower than to the out-of-the-money calls.

To formally test the speed of the stock market's reaction, Table 7 examines the cumulative returns over the selected intervals.The table also provides strong and significant evidence that the stock market's reactions to the in-the-money calls are spread overa period of time lasting up to more than 6 h but the reaction to the out-of-the-money calls is concentrated in the periodimmediately following the announcement.

As a robustness check, we also examine the returns in the half hour intervals of the groups with different announcementtimes. These results, available on request, show that the main conclusions from above remain the same. Across the three differentgroups, the stock market's reaction to the in-the-money calls is slower than its reaction to the out-of-the-money calls. Especially,even for the in-the-money calls announced in the evening, the stock market is slow in the sense that the average overnightannouncement effect is only −0.79% but the average reaction during the rest of the following day is −1.05%.

As another robustness analysis, we examine the speed of the stock market's reaction using five- and fifteen-minute intervals.These results confirm that the stock market's reaction to the in-the-money calls is much slower than for the out-of-the-money calls.

-1.80%

-1.60%

-1.40%

-1.20%

-1.00%

-0.80%

-0.60%

-0.40%

-0.20%

0.00%

0.20%

-15 -10 -5 0 5 10 15 20 25 30

Average half-hour return Cumulative average half-hour return

Fig. 1. The stock price reaction to the in-the-money call announcements. This figure shows the reaction of the underlying stock prices to the in-the-money callannouncements. The chart plots the cumulative returns beginning 7 h before the announcement at half hour intervals. The returns are calculated based on themid-quotes as close as possible to the end of each half hour period. The announcement is made during interval −1.

-0.25%

0.25%

0.75%

1.25%

1.75%

2.25%

-15 -10 -5 0 5 10 15 20 25 30

Average half-hour return Cumulative average half-hour return

Fig. 2. Stock price reaction to the out-of-the-money call announcements. This figure shows the reaction of the underlying stock prices to out-of-the-money callannouncements. The chart plots the cumulative returns beginning 7 h before the announcement at half hour intervals. The returns are calculated based on themid-quotes as close as possible to the end of each half hour period. The announcement is made during interval −1.

Table 7The returns over the selected intervals relative to the announcement time.

Time relative to announcement ITM OTM

Mean return Returns b0 relative to non-zero Mean return Returns N0 relative to non-zero

−5.00: −2.30 −0.01% 53% 0.14% 50%−2.30: 0.00 −0.24%*** 55%** 0.18%** 57%**0:00: 0:30 −0.70%*** 70%*** 1.37%*** 79%***0:30: 3:30 −0.45%*** 62%*** 0.15% 53%3:30: 6:30 −0.20%*** 56%** −0.02% 48%6:30: 14:00 0.05% 50% 0.10% 50%

The test for the significance of the return in the individual event periods is calculated based on the bootstrapped p-value whereas a nonparametric t-test is used totest if the fraction of the negative returns is different from the fraction of the positive returns. The ⁎⁎⁎, ⁎⁎, ⁎ and denote significance at the 1%, 5%, and 10% levelsrespectively. The ITM is the in-the-money calls, and the OTM is the out-of-the-money calls.

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All in all the results from the intraday study provide strong evidence that the stockmarket's reaction to the out-of-the-money callsis quite immediate and precise, whereas the reaction to an in-the-money call is slow and can last up to 7 h following theannouncement. Given an information explanation for the announcement effect of the convertible bond calls, an explanation of whythemarket's reaction to the in-the-money calls should be so slow compared to out-of-the-money calls is quite difficult. Of course, oneexplanation could be that the response to the negative news is generally slower than to positive news. However, the reaction timefound here is far from the reaction timedocumented in the cases of other announcements of negative information. For example, Busseand Green (2002) find that the response to negative information reported by CNBC lasts 15 min. Similar results in the case ofdividends, earnings announcements, and analysts' revisions do not provide evidence of longer response times.17

Furthermore, there are a number of reasons to believe the in-the-money calls should be reacted to faster than theout-of-the-money calls. First, the in-the-money calls are more common than the out-of-the-money calls. Second, the impressionfrom our conversations with the managers of convertible bond funds and hedge desks, as well as from much of the literature onconvertible bonds, is that quite often the in-the-money calls are anticipated.18 Third, the firms making the in-the-money calls are

17 See, for example, Patell and Wolfson (1984), Jennings and Starks (1985), Barclay and Litzenberger (1988), and Juergens (2000).18 For example, Calamos (1998, p. 202) states that “In most cases the marketplace has anticipated the call”when writing about the in-the-money calls. Similarly,the pattern in short selling before the call and its role in explaining the announcement effect as documented in Bechmann (2004) also suggests that the in-the-money calls can be predicted to a certain degree. Finally, Grundy and Verwijmeren (2013) find that the use of dividend protected conversion rights has impliedthat the in-the-money calls for these are predictable.

Table 8The OLS and outlier-robust regression model for intraday announcement effects.

OLS results

Model A Model B

ITM OTM ITM OTM

Intercept −0.0178*** 0.0163 −0.0246** 0.0164IMBAL_SH 0.0208*** −0.0058 0.0183*** 0.0011SIZE −0.0221 0.0492** −0.0158 0.0474**Probability of no conversion 0.0008 −0.0040 0.0087 −0.0103Market Fixed Effects No No Yes YesIndustry Fixed Effects No No Yes YesYear Fixed Effects No No Yes YesNumber of observations 364 190 364 190Adj. R2 0.0285 0.0335 0.1145 0.1366

Robust results

Model A Model B

ITM OTM ITM OTM

Intercept −0.0093*** 0.0041 −0.0206** 0.0116IMBAL_SH 0.0106** −0.0023 0.0108** 0.0081SIZE −0.0330* 0.0512*** −0.0269 0.0357**Probability of no conversion −0.0121 0.0070 −0.0060 −0.0053Market Fixed Effects No No Yes YesIndustry Fixed Effects No No Yes YesYear Fixed Effects No No Yes YesNumber of observations 364 190 364 190

The results from a standard OLS and an outlier-robust regression technique (Holland andWelsch, 1977) with our intraday announcement effect as the dependentvariable. The ITM refers to the in-the-money calls and OTM to the out-of-the-money calls. The IMBAL_SH is the order imbalances normalized by total volume overthe announcement day, SIZE for the ITM is the number of new shares to be issued on conversion divided by the number of shares outstanding before the call, andthe SIZE for the OTM is the aggregate call payment divided by the total market value of equity before the call. Probability of no conversion is the physicalprobability that the conversion option will end out-of-the-money at the end of the conversion period. The Market Fixed Effects, Industry Fixed Effects, and YearFixed Effects control for differences between stock exchanges, industries, and across years. The ⁎⁎⁎, ⁎⁎, ⁎ and denote significance at the 1%, 5%, and 10% levelsrespectively.

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actually somewhat more liquid than the firms making the out-of-the-money calls. Therefore, the evidence suggests that a largefraction of the in-the-money calls is caused by the price pressure in the period following the announcement.

5.3. Intraday announcement effect

The stock market's reaction to the in-the-money calls is spread over a period of up to 7 h after the announcement. In order totake this relatively slow reaction into account and in turn obtain a more precise estimate of the announcement effect forannouncements made at different times of the day, we calculate the announcement effect as the accumulated return from 30 minbefore the call to 7 h after the call. For consistency, we also calculate our main proxy for the price pressure, the order imbalance bytrade volume (IMBAL _ SH), over the same time period.

Table 8 repeats the cross-sectional regression from subsection 5.1 but with this intraday announcement effect as thedependent variable. The results from this multivariate analysis are consistent with the earlier results. For brevity, we limit ourdiscussion to the key parameters of interest. For the in-the-money calls, the observed announcement effect is clearly related tothe IMBAL _ SH and not to the SIZE. The magnitude of the order imbalance coefficient is slightly higher than our earlier estimate.For the out-of-the-money calls, the IMBAL _ SH does not provide any additional explanatory power for the announcement effectbut the SIZE continues to be a significant determinant.

6. Conclusions

In this paper, we use two new approaches to examine the stock market's reaction to the announcement of convertible bondcalls. First, we examine a large data set of both in- and out-of-the-money calls that allows us to examine the differences in thestock market's reactions to both types of calls. Second, the data set includes the exact time of the call announcement that makespossible the study of the stock market's reaction in hours and minutes around the call announcement and to estimate variousproxies for the price pressure around the announcement. Therefore, instead of having to study the long-run stock performance ofthe calling firm, we can muchmore directly distinguish the signaling and price pressure effects and avoid the problems associatedwith a focus solely on long-run reactions.

Our results show that the announcement effect is negative for the in-the-money calls and positive for the out-of-the-moneycalls. However, as a new finding, we show that the stock market's reaction to the in-the-money calls takes up to 7 h, but the

148 K.L. Bechmann et al. / Journal of Corporate Finance 24 (2014) 135–148

out-of-the-money call is incorporated into the stock price in less than half an hour after the announcement. Such a slow reactionby the stock market to the in-the-money calls suggests that the price pressure is the main cause. Various cross-sectionalregressions confirm this finding by showing that the announcement effect is significantly related to several proxies for the pricepressure in the period immediately following the announcement.

For the out-of-the-money calls, there is no significant relation between the announcement effect and the proxies for thepossible price pressure in the period after the call. These findings together with the immediate reaction of the stock marketsuggest that this reaction is a signaling effect. We provide further new evidence for this finding by showing that theannouncement effect of the out-of-the-money calls is instead significantly related to the size of the called convertible bond andthe information on how the redemption is financed. In conclusion, our main contribution is that the stock market's reaction to aconvertible bond call is no longer a puzzle.

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