Forthcoming: European Financial Management Journal

Why European Firms issue Convertible Debt?

Franck Bancel ESCP-EAP, European School of Management, 79 av. de la république, 75543 Paris, France

e-mail: bancel@escp-eap.net

Usha R. Mittoo Asper School of Business, Faculty of Management, Department of Accounting and Finance, 660

Drake Centre, 181 Freedman Crescent, Winnipeg, Manitoba, Canada. e-mail: umittoo@ms.umanitoba.ca.

ABSTRACT We survey European managers to gain some insights into motivations of convertible issuance. Our analysis shows that a majority of firms issue convertibles as “delayed equity” and as “debt sweetener”. Managers also use convertibles to avoid short-term equity dilution and to signal firm’s future growth opportunities. We document a large cross-sectional variation across firms in rationales for issuing convertibles and find mixed support for most theoretical models. Our evidence suggests that the popularity of convertibles is driven primarily by their versatility in adjusting their design to fit the financing needs of individual firms, and by their increased demand among institutional investors. Keywords: Convertible Debt, European Managers, Survey, Delayed Equity, Debt Sweetener JEL Classification: G32, G15, F23. Corresponding author: Usha R. Mittoo* * We are grateful to all Chief Financial Officers who have participated in this study and to Exane, BNP Paribas and

Merrill Lynch corporate finance teams for their valuable comments and suggestions on our survey project. We also thank

Lemma Senbet, Ales Berk, Steven Wang, and participants at the 2003 European Financial Management Association

meetings and the 2003 Multinational Financial Society meetings for their helpful comments, and Phalguni Dave for

research assistance. Mittoo acknowledges financial support from the Bank of Montreal Professorship.

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Executive Summary

Why firms issue convertible debt has both intrigued and puzzled financial researchers. While a rich

theoretical literature has developed to explain rationales for convertible issuance, the empirical

evidence is mixed. The goal of this paper is to examine the link between theory and practice of

convertible issuance though a survey of European managers. Our survey spans sixteen European

countries and explores many aspects of convertible issue decision that have not been examined in the

previous surveys. We ask questions relating to theoretical models as well as to the demand and

supply side factors that may have contributed to the recent growth of convertible markets.

We receive responses from eight European countries including France, Germany, and U.K.

and our analysis shows some interesting findings. We find that a majority of firms issue convertibles

as “delayed equity” and as “debt sweetener” but managers also use convertibles to avoid short-term

equity dilution, and to signal about the future prospects of the firm. Convertible issuers include small

and large firms, high and low growth firms, closely and widely held firms, as well as firms with

undervalued and overvalued stock. Most firms use convertibles as an alternative to debt, and

primarily for refinancing, capital budgeting, and merger and acquisitions activities. The convertible

features as well as the conversion policy vary widely across firms. For instance, about one third of

firms consider call provision as unimportant and do not include a trigger to induce conversion of

bonds. Managers also view that a combination of low interest rates and high stock market volatility

is a good “window of opportunity” for issuing convertibles. Most managers also perceive

significantly positive net benefits of convertibles compared to the alternatives considered, despite the

negative stock price reaction to the issuance of convertibles reported by most of them.

Our analysis supports four main findings. First, we find a mixed support for most theories on

convertible issuance. Overall, there is moderate support for Stein (1992), Mayers (1998), Brennan

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and Kraus (1987), Brennan and Schwartz (1988) models but less support for Green (1984) and

Constantinides and Grundy (1989) models (for a summary of evidence see appendix 1). Second, it

appears that the need for financial flexibility and concern for earnings per share dilution documented

in capital structure surveys by Graham and Harvey (2001) and Bancel and Mittoo (2002) also

influence the issuance of convertibles. Third, there is a large variation in motivation for issuing

convertibles and in features of convertible issued, such as initial conversion premium across our

sample firms. There is also variation across countries. French managers value convertibles primarily

as “delayed equity” and care less about for the tax advantage compared to their other European

peers. This evidence suggests that popularity of convertibles may be driven primarily by their

versatility in adjusting their design to meet the individual financing needs of different clienteles.

Finally, our evidence also supports that both demand and supply side factors have contributed to the

surge of convertible bond market in Europe as argued by Noddings et al. (2001). A majority of

holders of bonds in our sample are institutional and hedge funds and about one fourth of these

convertibles are issued for merger and acquisitions.

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Why European firms issue convertible debt?

1. Introduction

Why firms issue convertible debt has both intrigued and puzzled financial researchers. The

convertible bonds are after all only a bundle of straight debt and call options on the issuer company’s

stock. What special advantages do they provide that cannot be mimicked by a unit offering of

straight bond debt and warrants? Yet the popularity of convertibles remains unabated and continues

to challenge researchers to come up with reasonable explanations. A rich theoretical literature has

also developed to explain rationales for convertible issuance but empirical evidence is mixed. The

goal of this paper is to provide some insights into the link between theory and practice of convertible

issuance through a survey of European managers.

Our survey complements and extends the literature in several aspects. First, most of the

previous managerial surveys on convertible debt issuance have been undertaken in the U.S. which

has a well-developed and mature convertible market. In contrast, the European convertible market

gained momentum only in the mid-1990s but has grown rapidly since then. Further, European

convertible bonds have several distinctive features not observed in the U.S. case.1 For example, in

addition to issuing the standard convertible debt security, many European firms also issue

exchangeable bonds where the options are written on securities of other firms. Also, many European

convertibles are denominated in a currency other than that of the underlying equity. Further,

convertible features, markets, and regulatory environments vary widely even across European

countries providing us a rich data set to explore cross-country differences.2 The French market

comprises about one third of the European market and is the fastest growing with a large base of

1 See Noddings et al. (2001) and Hope (2000) for description and special features of the European convertible market. 2 See for example, Amman et al. (2003), Pablo (1993), De Roon and Veld (1998), and Veld (1994) for distinctive

features of the French, Spanish and Dutch convertible bonds respectively.

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private and institutional investors. In this study, we compare managerial perspectives of French

versus other European firms to gain some insights into factors that may have spurred growth of the

French convertible market.

Second, the direct empirical evidence on motivations for issuing convertibles consists largely

of managerial surveys, beginning with the first such survey by Pilcher in 1955.3 In addition, several

studies provide indirect evidence by studying characteristics of the issuers, offerings, and call

features. Despite a preponderance of these studies, the empirical evidence is mixed. As Mayers

(1998) observes that a problem with existing evidence on convertible bonds is that it is consistent

with sequential-financing hypothesis as well as with after-issue risk shifting, risk estimation and

asymmetric information theories. Another major problem is that managerial motivations are likely to

change over time, making it difficult to interpret evidence from studies conducted over different time

periods, each covering different aspects of convertible issuance.4 The main contribution of our study

is to examine several aspects of convertible bond issuance in the same sample. We ask managers

questions not only on the rationale for issuing convertibles but also on other aspects of convertible

bonds such as the use of funds, influence of market conditions, and on the firm’s callable policy.

This allows us to examine both direct and indirect implications of different theories in the same

sample.

Finally, the interplay between theoretical development and survey evidence on rationales for

issuing convertibles has been a continuous process. While evidence produced by earlier surveys

appears to have motivated theoretical development in the 1980s and 1990s, theoretical developments

in turn have led to more comprehensive surveys over time. Our survey continues this ongoing

interaction by analyzing several new theories not examined in the previous surveys. Our approach is

3 Other surveys include Brigham, 1966; Hoffmeister, 1977; Billingsley and Smith, 1996; Graham and Harvey, 2001; and

Bancel and Mittoo, 2002. 4 See for example, Billingsley and Smith (BS, 1996) who document a change in managerial motivations over time.

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closer to that of Billingsley and Smith (BS, 1996) who combine analysis of market reaction to the

announcements of convertibles issues with that of managerial survey data but differs from theirs in

several dimensions. Our survey spans sixteen European countries and relates our findings relative to

recent surveys on capital structure by Graham and Harvey (GH, 2001) and Bancel and Mittoo (BM,

2002).

We receive responses from eight European countries and our analysis shows some interesting

findings. A majority of firms issue convertibles as “delayed equity” and as “debt sweetener”.

Managers are also concerned about equity dilution and use “windows of opportunity” when issuing

convertibles. However, there are substantial cross-sectional variations in reasons for issuing

convertibles as well as in features of convertible bonds issued. Overall, we find mixed support for

most theories on convertible issuance. The evidence suggests that convertibles appeal to different

clienteles because of their versatility of design fitting in the financing needs of individual firms, and

the investment needs of different institutional investors.

The rest of the paper is organized as follows. The next section reviews the literature on

rationale for convertibles and discusses the survey design. Section 3 discusses the survey

methodology and survey sample characteristics. Empirical analysis is presented in section 4 and

summary and conclusions in the last section.

2. Literature Review

While a rich theoretical and empirical literature on pricing and call policies of convertible bonds has

emerged in the last three decades, relatively few studies have focused on the rationale for using

convertibles. Brennan and Schwartz (BS, 1988) observe, “To the perplexity of academics, however,

the popularity of convertibles has shown little sign of abating. Consequently, as “positive” financial

economists, we have been faced with the task of finding a convincing explanation for the corporate

use of convertibles – one that is consistent with rational investors and sophisticated financial

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markets.” In this section, we first review the theoretical and empirical literature pertaining to the

rationale for convertible issuance.

2.1. Theoretical Models

In most theoretical models, convertibles generally resolve either a financing or an investment

problem. Earlier models emphasized the role of convertibles in resolving risk-shifting or risk-

assessment problems associated with a firm’s assets in place. Green (1984) develops a model in an

agency framework in which interests of shareholders are in conflict with that of bondholders.

Shareholders prefer high risk projects since they gain when investment returns are above those

required to service debt payments but have limited liability when returns are low. Managers working

as agents of the shareholders have an incentive to engage in riskier projects in conflict with

bondholders’ preference for low risk projects. Convertible bonds provide the bondholders an option

on converting their bonds to the underlying stock and, consequently, reduce their concern about ex-

post risk-shifting. Brennan and Schwartz (BS, 1988) and Brennan and Kraus (BK, 1987) develop

models in a setting in which investors have difficulty in assessing the risk of firm’s assets in place.

Issuing convertible debt, instead of straight debt, in such a setting helps in resolving uncertainty

about this risk. In BK (1987) model, managers can also signal the riskiness of the firm by choosing

terms of the convertible contract. A major implication of the risk-based models is that firms that have

higher uncertainty about risk of their assets such as high growth firms are likely to be the major

issuers of convertible debt. The risk-based models do not have a clear cut role for the callability

provision.

Constantinides and Grundy (CG, 1989) and Stein (1992) develop models in the asymmetric

information framework of Myers and Majluf (1984) in which managers have superior information

relative to investors about the risk and cash flows associated with firm’s assets in place. Stein’s

model is developed on the assumption that financial distress is costly, and that excessive debt

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increases the probability of financial distress. Stein argues that if firms privately know that their

stock is undervalued, they prefer to avoid issuing equity but also want to minimize the distress costs

that come with debt issuance. Convertible debt resolves this financing problem through “backdoor

equity” that has lower distress costs than debt financing but has smaller undervaluation compared to

equity financing. The call feature is critical in Stein’s model to force investors to exercise their

conversion option early, and to induce them to swap their bonds for firm’s stock to help avoid

financial distress. In CG’s model, on the other hand, callability is not important but convertibles must

be combined with a publicly observed stock repurchase to have the desired separating equilibrium.

In a recent paper, Mayers (1998) develops the rationale for convertibles using agency

framework of Jensen (1986) in which managers have incentives to make inefficient investment in the

presence of free cash flow (overinvestment problem). Providing funds upfront for both the initial

project and the investment option sets up an incentive conflict between the manager and investors

because of the overinvestment problem. Convertible bonds resolve this sequential-financing problem

by controlling the overinvestment problem as well as economize on issue costs by avoiding multiple

issues of debt and/or equity. The call option is valuable in Mayers’s model because it provides

flexibility in financing future profitable investments as and when funds are needed.

Overall, while the call option is valuable in both Stein and Mayers models, there are several

notable differences between the two models. In Stein’s model, convertible issuers are likely to have

undervalued stock and high debt-to-equity ratio whereas in Mayers’s model they are likely to be high

growth firms and may have overvalued stock at the time of issue. Also, in contrast to Stein’s model,

the asymmetric information in Mayer’s model is about the value of future investment option, not

about the assets in place.

2.2 Empirical Evidence

2.2.1 Survey Evidence

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Most of the empirical evidence on the rationale for convertibles consists primarily of managerial

surveys. The first such survey was conducted by Pilcher in 1955 who asked managers to select

between two choices for issuing convertibles: to “sweeten” the debt and to issue as “delayed equity”.

An overwhelming majority of respondents (82 percent) chose “delayed equity” as their main reason

for using convertibles. These findings were also confirmed by Brigham (1966) who documented that

73 percent of managers reported that their primary motivation in issuing convertibles was to obtain

equity financing, and of those who preferred this response, about 68 percent also believed that their

stock price would rise over time. In contrast, Hoffmeister (1977) reported that only 34 percent of

respondents selected “delayed equity” as their first choice from among seven rationales for

convertible issuance. He also found differences in industrial and financial firms; about 47 percent of

the industrial firms picked “delayed equity” while 41 percent of the financial firms selected “debt

sweetener” as their first choice.

In a recent study, Billingsley and Smith (BS, 1996) survey managers on the motivations for

convertible issuance as well as examine the relation between observed market reactions to the use of

the convertible debt and the stated motivations for its use. They find that both “debt sweetener” and

“delayed equity” are selected as the top two choices by a similar number of managers and receive

similar rankings. In addition, straight debt is considered as the main alternative to convertibles (35

percent), followed closely by common stock as the second choice (32 percent). They conclude that

their findings, viewed in the context of the earlier work, confirm a steady trend toward a decreasing

reliance on convertibles as delayed equity financing.

Graham and Harvey (GH, 2001) examine motivations of convertible issuance in a managerial

survey on capital structure policy. In contrast to the findings of BS (1996) survey, they report that 58

percent of managers cite “delayed equity” as the main reason for using convertibles while only 42

percent cite that it is less expensive than straight debt. One plausible explanation for this difference

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could be that while BS (1996) request a response relative to a specific offering among firms that

actually issue convertible debt, GH (2001) condition only on whether a firm has seriously considered

issuing convertibles. Bancel and Mittoo (BM, 2002) conduct a survey of European managers on their

capital structure choices. Their findings are largely consistent with those in GH (2001) but they

report significant differences in managerial rankings of determinants of convertible policy across

European countries. For example, factors such as the ability to “call’ or the flexibility to force

conversion are ranked the lowest in English law countries, and the highest in the Scandinavian law

countries while the reverse is true for short-term equity dilution factor. French and German law

countries’ managers, on the other hand, assign very similar rankings to most factors.

2.2.2 Indirect Evidence

Several studies provide indirect evidence pertaining to rationales of convertible issuance based on

characteristics of convertible issuers, importance of call provision, and stock price reaction to

announcements of convertible issuers.5 In general, evidence suggests that firms that have high

growth opportunities or high stock volatility tend to be the heavy users of convertible bonds,

consistent with most theoretical models. Further, evidence that most bonds are callable, and that a

large fraction of convertible bonds are ultimately converted is interpreted as consistent with both

Mayers and Stein models.6 A negative stock price reaction to announcement of convertible issuance

is consistent with Stein’s model as well as with the pecking-order model of capital structure. While

the U.S. evidence generally supports a negative stock price reaction to convertible issuance,

European evidence is mixed and shows differences across countries.7

5 See Stein (1992), and Mayers (1998) and Harris and Raviv (1991) for a summary of this evidence. 6 See for example, Asquith (1991) and Essig (1991) 7 For U.S evidence, see Dann and Mikkelson (1984), Eckbo (1986), and Mikkelson and Partch (1986). These studies

show that stock price reactions to convertible issues is, on average, significantly negative (around –2 percent), but is less

negative than for equity issues (about –3 percent) and more negative than for straight debt issues (-0.3 percent). For

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3. Methodology and Sample characteristics

3.1. Survey Design

Most previous surveys have focused mainly on the motivations of convertible issuance. We design a

more comprehensive survey questionnaire that includes questions relating to all major aspects of

convertible bonds that have been used in previous studies to draw inferences pertaining to different

theoretical models. A major advantage of our approach is that it allows us to investigate both demand

and supply side factors of convertible bond issuance in the same sample. A major cost of such an

approach is that it requires more time from managers to complete the survey, and consequently, is

likely to result in a low response rate.

The first draft of the survey was developed after a careful review of the theoretical literature

pertaining to the U.S. and European countries. The draft questionnaire was tested by academics and

financial executives, and was revised after incorporating their feedback and suggestions. To increase

the response rate, we limited the length of the survey to two pages. The survey was anonymous and

tests showed that it took approximately 25-30 minutes to complete.

3.2. Initial Sample

Our initial sample consists of all firms that had at least one convertible bond issue listed on a

European Stock Exchange in May 2002. From this list, we exclude firms with exchangeable bond

issues.8 These firms are identified by combining several databases obtained from BNP Paribas,

Exane, and Merrill Lynch, and by examining the financial pages of European newspapers and

European stock exchange web sites. The final sample consists of 229 firms with 295 issues in 16

European countries.

European evidence, see Abhyankar et al. (1999) who document a negative reaction to convertible announcements in the

U.K. and De Roon and Veld, (1998) who report a positive reaction to convertible announcements in the Dutch market.

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Table 1 presents breakdown of our sample by country and issue size. Five countries, France,

Italy, Netherlands, Switzerland, and UK represent over 80 percent of the convertible bond listings.

France has the largest number of convertibles listed (98), almost twice that for the UK (52) or

Switzerland (43). The total market capitalization of our sample bonds is 98 billion euros. The French

market is also the largest in terms of market capitalization of the bonds representing 32.4 percent of

the total market, followed by the UK (18 percent) and the Swiss (17.7 percent) markets. Table 2

reports average firm size, debt-to-equity ratio, and annual sales for our sample issuers for the year

ending December 2001. There is considerable variation in firm size, total assets, average sales and

leverage across countries and a majority of issuers belong to manufacturing (21.8 percent), financial

(17.9 percent), and technology (14 percent) sectors.9

[Insert Table 1 and Table 2 about here]

3.3 Respondent Firms

The survey was mailed to the Chief Financial Officers (CFO) of all sample firms whose names and

addresses were available on the Bloomberg database.10 The first mailing was undertaken in

November 2002, followed by a second mailing in February 2003. A total of 29 responses from eight

countries were received by mail or by fax. This represents a response rate of 12.7 percent and

compares favorably with those of previous surveys by GH (2001) and BM (2002). About half of the

respondents are from France which is not surprising since France dominates our initial sample

representing about one third of the sample.

8 Exchangeable bonds have a call option written on a stock different from that of the issuing firm and are commonly

used by European firms to sell their cross-holdings in other firms. 9 Noddings et al. (2001) report that technology – media – telecommunication (TMT) group is the largest market sector by

market capitalization, and it has replaced banks and insurance companies that dominated the market for several years. 10 Data have been provided by BNP Paribas. The survey was mailed to the Chief Executive Officer (CEO) when the

name of the CFO was not available.

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Figure 1 presents characteristics of the respondent firms. Our sample is dominated by large

and medium size firms. Large (sales greater than five billion euros) and medium size (sales between

one and five billion euros) firms comprise over 88 percent of the respondents. These proportions are

very similar when book value of assets is used to proxy firm size. The average (median) market

capitalization of the respondents is about 5.9 (4.5) billion euros and it varies from minimum of 400

million euros to a maximum of 30 billion euros. A majority of the respondent firms (55 percent) are

also high growth firms with price to earnings (P/E) ratio greater than 14. Most firms also have strong

international orientation; about 60 percent of them have a majority of their sales in foreign countries,

and about 25 percent are listed on the U.S exchanges. The long-term debt-to-equity ratio was

reported by about one third of respondents, and it varies from 0.2 to 1 with an average of 0.55.

[Insert Figure 1 about here]

The respondent firms represent a wide variety of industries with a larger concentration in

services and transport (about 25 percent) and manufacturing (17 percent). About 70 percent of the

firms are widely held public firms, with free-floating shares averaging about 50 percent of the total

shares outstanding. Most of them (77 percent) pay regular dividends, with payout ratios ranging from

23 percent to 66 percent. Non-utility firms comprise over 80 percent of the respondents. Overall, our

sample represents a broad cross-section of firms from different European countries.

4. Survey Results

We first present a summary of managerial responses on all survey questions and then examine

correlations among different responses for a richer analysis. A summary of the link between different

theories and our survey evidence is presented in Appendix 1.

4.1. Summary of Managerial Responses

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4.1.1. Evidence on Rationales for Convertible Issuance

(i) Major Factors affecting Convertible Issuance

We ask managers to rank the importance of different factors in their decision to issue convertibles.

These factors can be divided broadly in three categories. The first set of factors is based on the

implications of different models of convertible bonds issuance discussed in section 2. The second set

of factors is drawn from the capital structure literature. For example, we ask managers questions on

the market conditions in issuing convertibles as evidence suggests that managers use “window of

opportunity” to issue debt or common stock.11 Finally, the last set of factors is based not on any

theoretical considerations but on commonly held beliefs among managers such as the potential

impact of equity issue on earnings dilution. The managers were requested to rank the importance of

each factor on a scale of 0 to 4 (with 0 as not important and 4 as very important).

Table 3 presents the summary of managerial ranking of these factors. “Delayed equity” in the

expectation that debt would be converted to equity is ranked as the most important factor (mean

rank=3.07), consistent with Stein’s “backdoor equity” model. About 86 percent of the CFOs rate this

factor as either important (rating=3) or very important (rating=4). The use of convertible debt to

signal the firm’s future growth opportunities to the market, consistent with both Mayers and BK

models, is also considered important or very important by 55 percent of managers (mean rank=2.41).

However, a direct implication of Mayers’s model that convertibles provide flexibility in financing

uncertain future investments as well as the callability provision which are critical in both Stein and

Mayers model, receive only modest support (mean rank about 1.62). Factors relating to the risk-

based models also receive less support. The main implication of the BS (1988) model that

convertibles help attract investors that are unsure of the risk of assets is considered less important

11 For example, see Korajczyk, Lucas, and McDonald (1991), and Bayless and Chaplinsky (1996) for tests of window of

opportunity hypothesis.

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(mean rank = 1.38) whereas that of Green’s model that convertibles resolve concern of bondholders

is considered unimportant (mean rank = 0.66).

[Insert Table 3 about here]

There is strong evidence that managerial beliefs about capital structure also significantly

influence their decision on convertible debt issuance. Over 72 percent of managers view convertible

debt to be less expensive than straight debt (mean rank=2.72). This evidence is consistent with “debt

sweetener” as a major motivation in issuing convertibles as well as with Mayers’s model that

emphasizes the lower issuance costs as a major advantage of issuing convertibles for sequential-

financing needs. Further, managers are also concerned about equity dilution similar to that in GH and

BM surveys; about 48 percent of managers agree that avoiding short-term equity dilution is a major

reason in issuing convertibles (mean rank=2.38). Other factors such as less covenants, increasing

book value of equity-to-debt ratio, tax advantage of interest deductions, and ability to reach

international investors are modestly important (mean rank >1) whereas following industry peers, and

reducing threat of a hostile takeover are considered unimportant (mean rank <1).

Table 3 (Columns 4-19) also presents the univariate tests of differences in responses based on

several firm and offering characteristics that may affect convertible issuance. There are significant

differences on some dimensions. Not surprisingly, small firms (with market capitalization of less

than five billion euros) value less covenants associated with convertibles more than large firms do

(mean rank 2.07 versus 1). Both small and domestic oriented firms (with majority of sales in

domestic market) also highly value the ability to reach international investors through convertibles.

Low growth firms place a significantly higher value on tax deductibility of interest payments while

non-dividend paying firms value the ability to force conversion as well as the flexibility in financing

uncertain future investments. Frequent convertible issuers (with more than two convertible issues

outstanding) place higher value on convertibles as “delayed equity” compared to other issuers (3.36

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versus 2.50), and on avoiding short-term equity dilution (2.93 versus 1.82). Firms that include a

trigger clause to force conversion also value less covenants and no rating required in convertibles.

Interestingly, French firms are more likely to issue convertibles as “delayed equity”, and are less

concerned with tax deductibility of interest compared to their other European counterparts. Overall,

the evidence suggests that convertibles appeal to different clienteles for different reasons.

(ii) Alternatives to Convertibles

We ask managers about what other financing alternatives did they consider prior to issuing

convertibles. This question is relevant since in Stein’s model firms wish to issue equity but are

unable to do so, whereas in Mayers, Green and BS models convertible debt is issued primarily as an

alternative to straight debt. As shown in Figure 2.A, about 70 percent of respondents consider

straight debt as an alternative to issuing convertible debt (mean rank > 2). In contrast, only 23

percent and 16 percent of them seriously consider equity or other synthetic securities as an

alternative. We also ask managers an open-ended question on their main reasons for selecting

convertible over other alternatives, and code their responses in five broad categories (see Figure

2.B). Over 60 percent of managers cite factors such as lower coupon than straight debt, callability

provision, etc. as major determinants of their decision to choose convertibles. Very few managers

cite factors such value of convertible as a signal of the firm’s growth opportunities (Mayers’s

model), and inability to issue debt (Stein’s model) in their responses.

Another open-ended question related to the use of funds raised through convertibles. Most

managers report that these funds were used primarily for refinancing (35 percent) and capital

budgeting activities (23 percent) (Figure 2.C), consistent with evidence in most previous studies.

About 23 percent of firms also use funds for merger and acquisition activities. Very few managers

report that proceeds were used for financing growth activities, an implication of Mayers’s model,

while none mentioned its use for stock repurchase which is a direct implication of the

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Constantinidies and Grundy model. We also asked respondents about their perceived net benefits in

issuing convertibles versus other alternatives. About 86 percent of respondents perceive that net

benefits are significant positive or marginally positive compared to the alternative considered (Figure

2.D). It is noteworthy that managers perceive positive net benefits despite reporting a negative

impact on their firm’s stock price at the time of issuance (see next section).

[Insert Figure 2 about here]

(iii) Market-Specific Factors

To examine whether managers use “windows of opportunity” when issuing convertibles, similar to

that in debt or equity case, we ask managers about the influence of market conditions at the time of

the issuance on their decision. Summary of their responses is provided in Table 4, and the evidence

supports that managers try to time the market in the case of convertibles also. Over half of the

respondents agree that both low interest rate environment and high stock market volatility were

important or very important in their decision to issue convertibles (mean rank about 2.6). Further, the

percentage of managers who perceive their firm’s stock to be undervalued (35 percent) at the time of

issuance is very similar to those who consider it to be overvalued (38 percent), supporting both Stein

and Mayers models. About one third of respondents also agree that liquidity of convertible market is

important or very important in issuing convertibles. Interestingly, this factor is valued much higher

by the French respondents. Not surprisingly, firms that issue convertibles to finance special projects

such as merger and acquisitions care less whereas frequent issuers care more for market conditions

when issuing convertibles.

[Insert Table 4 and Figure 3 about here]

In asymmetric information framework models, market reaction to convertible bond

announcements is expected to be negative. Figure 3.A summarizes managerial responses on market

reaction to convertible issues. Over 62 percent of managers report that the market reaction to the

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convertible issue was negative (only 5 percent report a positive market reaction), consistent with that

reported in most previous studies. The mean (median) percentage impact on stock price is -3.5 (-4)

percent and it ranges from a minimum of –10 percent to a maximum of +5 percent.

(iv) Conversion Policy

We also ask CFOs about major factors that determine their firm’s conversion policy which is critical

in both Stein and Mayers models. Table 5 summarizes their responses and we find mixed support for

both models. While about 28 percent of firms agree that forcing the conversion would be done when

future investment opportunities occur, consistent with Mayers’s model, about 31 percent also agree

that conversion of the issue is not important to them, inconsistent with both Mayers and Stein

models. Further, about one-third of managers are also concerned that forcing the conversion would

impact the earnings per share significantly. There are some differences in responses based on firm

and offering characteristics. Large firms are more concerned than small firms that forcing the

conversion would dilute earnings (mean of 2.55 versus 1.38). High growth firms plan conversion as

and when future investment opportunities arise, and care less about loss of tax deductibility,

consistent with Mayer’s model. Not surprisingly, managers who are concerned that conversion close

to the premium would be unpopular with the investors as well as those who prefer indirect

conversion through raising dividends are also less likely to include a trigger clause. Overall, the wide

variation in managerial views on conversion policy documented in our survey is consistent with that

reported in Brigham (1966) survey.12 This variation may partly explain the puzzling empirical

evidence that not all firms call their convertible bonds as soon as they become callable, and some

bonds even expire without being called as documented in studies such as Asquith (1991).

[Insert Table 5 about here]

18

4.1.2. Other Factors

(i) Demand of Convertibles

To examine the importance of the demand side factors, we ask managers about the holders of their

bonds at the time of the issue. Their responses are summarized in Figure 3.B. An overwhelming

majority of convertibles (over 80 percent) at the time of issue are placed with institutional investors,

with average holding of about 55 percent. Hedge funds are also major investors in convertible bonds

with about 34 percent of the average holding. In comparison, banks and private investors hold

relatively small percentage of convertible bonds.

(ii) Design of Convertible Securities

A major advantage of a convertible bond is that its design can be adjusted to make it look more like

debt or equity type security by varying its features such as call protection, maturity, and conversion

price. Several recent studies have focused on this aspect of convertibles by extending Stein and

Mayers models. For example, Lewis, Rogalski and Seward (1998a) extend Stein’s model to

incorporate the case in which firms that are more confident about their future prospects issue

convertibles with shorter call protection periods and find support for this prediction. Lewis, Rogalski,

and Seward (1998b) also find evidence that those firms that are predicted to issue equity are likely to

issue convertibles that are more equity-like, and those that are predicted to issue debt issue more

debt-like convertibles. Korkeamaki and Moore (2002) provide evidence of a connection between

issuers' investment patterns following the convertible issue and call protection terms on their issues

as implied in Mayers’s model. Korkeamaki (2002) finds that call protection of convertible issues

varies across different legal system countries defined in La Porta et al. (1997, 1998); firms in

12 Brigham reports that only 23 percent of managers planned to force conversion as soon as it is assured, another 23

percent planned to encourage conversion by raising dividend, and the remaining 53 percent had no clear plan of

conversion

19

countries with strong shareholder rights protection tend to issue convertibles with soft protection

whereas those in countries with weak shareholder rights tend to issue convertibles with hard call

protection.

We ask managers several questions on features of their firm’s latest convertible bond issue.

Figure 4 shows that there is a wide variation in these features. The average (median) issue size is 520

(400) million euros with over 90 percent of issues being over 100 million euros. As a percentage of

asset size, the average (median) issue size is 10.7 (7.5) percent but it varies from a minimum of 1

percent to a maximum of 50 percent. A majority of the convertibles (66 percent) have a trigger

clause to force conversion, but very few convertibles have any preemptive rights or other covenants.

There is also a wide variation in initial and trigger premium. While some convertibles are issued at

par, others have initial premium as high as 131.5 percent of the par value. Mean (median) trigger

premium is 28 (30) percent but it ranges from par value to 150 percent of the par value. Most of the

issues also have a credit rating, and about half of them have a rating of A and above. This is

consistent with Noddings et al (2001) who report that over two-thirds of European convertibles are

rated investment grade by Moody’s or Standard and Poor, and a majority of non-rated convertibles

are from financially strong companies. This large variation in the characteristic of convertibles in our

sample indicates that firms adjust various features of convertible bonds to fit their special financing

needs.

[Insert Figure 4 about here]

We also ask CFOs questions on their capital structure policies. About 63 percent of

respondents have a target debt-to-equity ratio, and about half of them maintain a target ratio of about

0.50. The convertible issuers also appear to frequently access the capital markets. As figure 4.C

shows, about 80 percent of the convertible issuers have issued debt or equity, and almost all of them

(95 percent) have also issued convertible debt during the past ten years. About half of our sample

20

issuers have over two convertibles issue outstanding but only a few of them have issued other

synthetic securities during the last ten years.

(iii) Role of Investment Advisor

Since convertible bond designing can be a complex task, the investment advisor is likely to play a

key role in this aspect. A majority of managers report that investment advisor played a medium level

role in their decision to issue convertibles. We also ask the CFOs how they selected their investment

advisor and what help did the advisors provide. The summary of responses is provided in Table 6.

Good relationship with investment bank (mean rank=3.04) and its reputation (mean rank=2.65) are

cited as the most important criteria in selecting the investment bank. Other important factors include

banking relationship and pricing (mean rank >2). Investment banks also played a major role in

pricing and designing the convertibles; about 56 percent of the respondents considered their help in

these aspects as important or very important (mean rank=2.68). Investment banks also help firms in

evaluating other alternatives but their advice to issue convertibles is based largely on favorable

market conditions. Not surprisingly, there are significant differences in small and large firms. Larger

firms and frequent users of convertibles rely less on investment bankers for advice and designing

compared to their smaller counterparts, similar to the findings in Billingsley and Smith (1996).

Overall, the evidence supports that investment bankers play a major role in designing and pricing the

security.

[Insert Table 6 about here]

In sum, our survey findings are largely consistent with those of Hoffmeister (1977), and

Billingsley and Smith (1996) in that both “delayed equity” and “debt sweetener” are considered

important reasons for issuing convertible bonds by a similar percentage of managers. The concern

about EPS dilution is consistent with those in GH and BM surveys as the major factor in driving

equity policy. Overall, there is mixed evidence for different theories on convertible issuance. Further,

21

evidence also supports that managers highly value the flexibility of design in convertibles to look

“debt” like or “equity” like securities and use “windows of opportunity” for convertible issuance.

4.2. Correlation Analysis

Table 7 presents Spearman rank correlation coefficients of survey responses. Panels A and B

presents correlations of major factors that affect convertible issuance decision (Table 3) with

alternatives considered, market conditions, determinants of conversion policy and with the issuer and

issue characteristics used in cross-tabulations in Tables 3-6.13

[Insert Table 7 about here]

The correlation analysis largely confirms the results of the previous section. First, mixed

support for different theories on rationale for convertible issuance is clear from Panel A. For

example, managers who issue convertibles as “delayed equity” are less likely to consider debt as an

alternative (Corr. = -0.40**) consistent with Stein’s model but are more likely to state that their stock

is overvalued (Corr. = 0.54***), contrary to his model. Similarly, managers who value convertibles

for financing uncertain future investments tend to value flexibility of callability provision (Corr. =

0.30*), consistent with Mayers’s model, but do not appear to set their conversion policy to finance

growth opportunities (Corr. = 0.04), as implied by his model.

Second, evidence shows that determinants of debt and equity policies also affect the

convertible debt policy. The concern about earning per share dilution, an important determinant of

equity policy, is also a primary motivation for convertible issuance. Managers who perceive their

firm’s stock to be overvalued are more likely to issue convertibles as “delayed equity” (Corr. =

0.54***) to avoid short-term equity dilution (Corr. = 0.24). Managers who view convertible debt to

13 For brevity, we focus only on those motivations or factors that are identified as important by managers (mean rank>1).

22

be less expensive than straight debt also use “windows of opportunity” by issuing convertibles when

interest rates are low (Corr. = 0.52***).

Third, Panel B shows that motivations for convertible issuance vary significantly across

firms. Small and medium size firms highly value the access to international investors (corr.=-

0.53***), and less covenants (Corr. = -0.56***) provided by convertibles. Large firms, on the other

hand, tend to have overvalued stock (Corr. = 0.35*), and are more concerned about equity dilution at

conversion (Corr. = 0.36*). As expected, high growth firms are more likely to plan their conversion

policy to finance future growth opportunities (Corr. = 0.61**), and care less about tax deductibility

(Corr. = -0.59***). French firms are more likely to issue convertibles as “delayed equity” (Corr. =

0.60***), view them as less expensive than straight debt (Corr. = 0.50***), and cite liquidity of the

convertible market as a major factor in their issuance (Corr. = 0.39**), compared to other European

firms.

Finally, evidence also suggests that firms use different convertible features to adapt them to

their individual needs. For example, firm issuing convertibles as an alternative to equity are more

likely to have a trigger clause (Corr. = 0.45**) compared to those issuing them as an alternative to

debt (Corr. =-0.21). High growth firms are more likely to force conversion policy as and when

investment opportunities arise whereas large firms tend to be more concerned that forcing conversion

would impact EPS (Corr. =0.36*). These cross-sectional differences suggest that firms may adjust

different features of convertibles to adapt them to their individual needs. This could partly explain

why most firms perceive net benefits of issuing convertibles to be positive despite reporting a

negative stock market reaction (Corr. = 0.11).

5. Summary and Conclusions

Why convertible bonds are such a popular financing vehicle has been a puzzling phenomenon for

financial researchers. Survey methodology has been commonly employed to examine theories

23

pertaining to rationale of convertible issuance. Our study updates previous survey evidence by

examining this issue in the European convertible market that has witnessed a dramatic growth in the

late 1990s.

Our analysis supports four main findings. First, we find a mixed support for most theories on

convertible issuance. For example, the importance of “delayed equity” in the survey responses is

neither related to depressed stock price, nor to the inability of a firm to issue equity or to the

importance of call provision, as suggested by Stein’s “backdoor equity” model. In fact, firms that

issue convertibles as “delayed equity” also tend to have “overvalued stock” and cite avoiding equity

dilution as a major motivation in issuing convertibles. Similarly, managers who value the flexibility

of convertibles in future financing tend to have overvalued stock consistent with Mayers’s model,

but do not appear to set their conversion policy to achieve this goal of future financing suggested by

Mayers. Overall, there is moderate support for Stein (1992), Mayers (1998), Brennan and Kraus

(1987), Brennan and Schwartz (1988) models but less support for Green (1984) and Constantinides

and Grundy (1989) models (for a summary of evidence see appendix 1).

Second, it appears that the need for financial flexibility and concern for earnings per share

dilution documented in capital structure surveys by Graham and Harvey (2001) and Bancel and

Mittoo (2002) also influence the issuance of convertibles. Firms with overvalued stock tend to use

“delayed equity” to avoid short-term equity dilution rather than “instant equity” to lock in their

favorable premium. Equity dilution remains one of the dominant concerns for about one third of the

managers even in setting their conversion policy. Firms also use ”windows of opportunity” by

issuing convertibles rather than straight debt in times of low interest rates to obtain lower coupon

rates.

Third, major motivations for issuing convertibles vary widely across firms. There is a large

variation in convertible features such as initial conversion premium, trigger clause, and maturity of

24

convertibles issued by the respondents. There is also variation across countries. French managers

value convertibles primarily as “delayed equity” and less about the tax advantage compared to their

other European peers. This evidence suggests that popularity of convertibles may be driven primarily

by their versatility in adjusting their design to meet the individual financing needs of different

clienteles.

Finally, our evidence also supports that both demand and supply side factors have contributed

to the surge of convertible bond market in Europe as argued by Noddings et al. (2001). A majority of

holders of bonds in our sample are institutional and hedge funds and about one fourth of these

convertibles are issued for merger and acquisitions. French issuers consider the liquidity of their

convertible market as a major factor in the increased use of convertibles consistent with Noddings et

al. (2001). The euro denomination of the European convertibles also appears to be a major advantage

in accessing the international investors, especially for smaller and medium size firms who also tend

to rely more on the investment banker for their advice. In contrast, large firms are most frequent

users of convertibles, and rely less on the advice of investment banks.

Our results should be interpreted with some caution since they are based on a small number

of respondents. Our sample includes very few technology firms that were the major issuers of bonds,

and is biased towards large and medium size firms. Further, we have also not examined the

population of firms that do not issue convertibles. Despite these limitations our study provides some

useful evidence on European convertibles. Moreover, our main finding that convertibles appeal to

different clienteles is based on the large cross-sectional variation observed in the characteristics of

convertible issues and issuers, conversion policy, and holders of these bonds. This cross-sectional

variation exhibited in our small sample is likely to increase even more in a larger sample.

25

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28

Table 1 Sample firms by country of origin

Convertibles: Market cap (mil euros)

% Number of issuing Firms %

Number of convertibles

listed%

Average convertible Market cap (mil euros)

AUSTRIA 73 0.1% 1 0.4% 1 0.3% 73 BELGIUM 2 113 2.2% 6 2.6% 8 2.7% 352 FINLAND 965 1.0% 6 2.6% 7 2.4% 161 FRANCE 31 774 32.4% 76 33.2% 98 33.2% 418 GERMANY 4 136 4.2% 14 6.1% 14 4.7% 295 GREECE 319 0.3% 1 0.4% 1 0.3% 319 IRELAND 1 104 1.1% 1 0.4% 2 0.7% 1 104 ITALY 8 013 8.2% 14 6.1% 21 7.1% 572 NETHERLANDS 10 669 10.9% 19 8.3% 28 9.5% 562 NORWAY 38 0.0% 1 0.4% 2 0.7% 38 POLAND 354 0.4% 1 0.4% 1 0.3% 354 PORTUGAL 1 610 1.6% 3 1.3% 4 1.4% 537 RUSSIA 100 0.1% 1 0.4% 1 0.3% 100 SPAIN 863 0.9% 3 1.3% 4 1.4% 288 SWEDEN 868 0.9% 8 3.5% 8 2.7% 109 SWITZERLAND 17 330 17.7% 31 13.5% 43 14.6% 559 UK 17 605 18.0% 43 18.8% 52 17.6% 409 Total 97 933 100.0% 229 100.0% 295 100.0% 428

Table 2

Characteristics of sample firms

Table 2: Characteristics of sample firms

Number of firms

Average Market capitalisation (million euros)

Average sales (million euros)

Total assets (million euros)

Median Debt ratio

AUSTRIA 1 143 1,867 1,409 469%BELGIUM 6 10,389 7,185 2,900 75%FINLAND 6 754 2,827 2,893 131%FRANCE 76 4,235 7,723 16,809 79%GERMANY 14 7,076 22,411 22,379 153%GREECE 1 3,995 1,789 19,585 31%IRELAND 1 239 154 422 701%ITALY 14 2,418 5,125 24,043 162%NETHERLANDS 19 3,790 8,943 6,646 92%NORWAY 1 58 1 1,025 1043%POLAND 1 51 420 331 1508%PORTUGAL 3 5,336 4,920 17,135 85%RUSSIA 1 924 439 973 31%SPAIN 3 22,343 21,146 2,921 118%SWEDEN 8 4,262 6,782 8,897 51%SWITZERLAND 31 11,935 8,974 14,172 32%UK 43 4,087 3,008 12,645 70%Total 229 5,480 10,445 13,919 75%

29

Fig. 1. Firm Characteristics

A: Sales (millions euros)

0%

10%

20%

30%

40%

50%

60%

<100 100-999

1000-4999

>5000

B: Assets (millions euros)

0%

10%

20%

30%

40%

50%

60%

70%

<100 100-999

1000-4999

>5000

C: Market capitalization(million euros)

0%

10%

20%

30%

40%

50%

>5000<1000 1000- 5000

D: Price/earnings ratio

0%

10%

20%

30%

40%

10-14 14-19 19-24 >24 <10

30

E: Foreign Sales (% of total)

0%

10%

20%

30%

40%

50%

60%

70%

1%-9% 10%-24% 25%-50% >50%

F: Industry

0%

5%

10%

15%

20%

25%

30%

Insu

ranc

e

Man

ufac

turin

g

Bank

s/di

vers

ified

finan

cial

Con

sum

er g

oods

Ser

vice

s/Tr

ansp

ort

Ret

aile

rs &

D

istri

buto

rs

Med

ia

Pha

rmac

eutic

als

Ene

rgy/

Util

ity

Tele

com

mun

icat

ion

G: Other characteristics

0%

20%

40%

60%

80%

100%

Yes NoPrivate Yes Public

Widely / closely

held

Utility/non-utility

No

Paydividends

Free Float

>50%<=50%

31

Table 3

Survey response to the question: What factors have affected your firm’s decisions about issuing convertible debt?

Yes No Small Large Growth Non-G Yes No Yes No Low High Normal Special <=50% >50%

1) Convertibles were "delayed equity " financing, expecting that the debt would be converted

85.71 3.07 3.57 2.57*** 2.86 3.31 3.22 3.00 3.10 3.00 3.06 3.13 2.50 3.36** 2.79 3.36 3.10 3.06

7) Convertibles were less expensive than debt 72.41 2.72 3.21 2.27 2.93 2.38 2.90 2.44 2.64 2.83 2.88 2.56 2.36 2.86 2.73 2.45 2.45 2.82

15) Convertibles provide a good signal to the market about our future growth opportunities

55.17 2.41 2.50 2.33 2.47 2.31 2.40 2.44 2.36 2.50 2.41 2.56 2.09 2.71 2.33 2.64 2.36 2.41

2) Issuing convertibles avoided short-term equity dilution 48.28 2.38 2.64 2.13 2.47 2.31 2.10 2.67 2.59 1.67 2.53 2.00 1.82 2.93** 2.53 2.36 2.91 2.06*

12) Convertible debt could be issued with less covenants than “classical” bonds

34.48 1.62 2.00 1.27 2.07 1** 1.30 1.44 1.45 2.00 2.18 0.78*** 1.27 1.64 1.87 1.45 1.18 1.82

3) Convertibles gave us the ability to "call" or force conversion of debt if/when we needed to

27.59 1.62 1.79 1.47 1.93 1.23 1.40 1.67 1.41 2.33* 1.76 1.33 1.45 1.36 1.80 1.55 1.45 1.71

11) Convertible debt was a debt funding that did not require a rating 25.00 1.32 1.62 1.07 1.60 0.83 1.10 0.67 1.19 1.50 2.00 0.56*** 1.09 1.23 1.67 0.80 1.27 1.25

5) Issuing convertibles increased the book value of equity/debt ratio 21.43 1.29 1.00 1.57 1.20 1.42 1.50 1.13 1.50 1.17 1.31 1.22 1.45 1.00 1.20 1.40 1.10 1.41

4) Convertibles allowed us to attract investors unsure about the risk of our firm

20.69 1.38 1.29 1.47 1.67 1.15 1.90 1.33 1.65 1.20 1.41 1.11 1.36 1.36 1.40 1.27 1.82 1.18

8) Convertibles induced tax advantage of interest deductibility 20.69 1.45 0.93 1.93*** 1.47 1.46 1.10 2.22** 1.41 1.67 1.47 1.11 1.45 1.43 1.47 1.64 1.36 1.53

13) Compared with debt, convertibles gave us the ability to reach an international investor basis

17.86 1.36 1.31 1.40 1.87 0.75** 1.30 1.22 1.38 1.33 1.31 1.56 1.00 1.31 1.93 0.7** 1.91 1*

14) Convertibles provide us flexibility in financing uncertain future investments as and when we need

17.86 1.64 1.85 1.47 1.47 1.83 1.60 1.33 1.43 2.33** 1.69 1.78 1.18 1.62 1.67 1.70 1.27 1.88

9) Other firms in our industry successfully used convertibles 13.79 0.83 0.93 0.73 1.07 0.54 0.70 1.11 0.68 1.33 1.00 0.33 0.82 0.79 0.73 0.91 0.64 0.94

6) Convertibles protected bondholders against unfavourable actions by managers or stockholders

3.45 0.66 0.86 0.47 0.53 0.77 0.60 0.44 0.50 1.17 0.59 0.89 0.73 0.64 0.60 0.73 1.00 0.41*

10) Issuing convertibles has helped us to reduce the risk of an hostile takeover

0.00 0.54 0.54 0.53 0.40 0.67 0.30 0.56 0.38 1.00 0.63 0.33 0.73 0.38 0.40 0.80 0.36 0.63

P/E

Respondents are asked to rate factors on a scale of 0 (not important) to 4 (very important). We report the overall mean as well as the % of respondents that answered 3 and 4 (very important).***,**,* denotes a significant difference as the 1%, 5%, and 10% level, respectively. The differences in means based on selected firm and issue specific variables are also reported. These include:France (whether the firm is a French firm), Size (large firms have market capitalization of at least of 5 billion euros), P/E (growth firms have P/E ratio greater than 14), Dividend (whether the firmpays dividend or not), Trigger (whether the convertibles contain a trigger clause to force conversion), Nissue (high is firms with more than two convertible issues outstanding), Use of funds (normaluses are for refinancing and capital budgeting purposes, special are for other purposes such as acquistions), and foreign sales (whether firm's foreign sales are greater than 50% of total sales).

Nissue Use of funds Foerign Sales% Important or very

importantMean

Dividend TriggerFrance Size

32

Fig. 2. Alternatives for Convertibles

A: Alternatives to issuing convertibles

0%

20%

40%

60%

80%

Straight debt Common stock Other convertible

Mean rank over 2

B: Factors that influenced selection of convertibles

0%

15%

30%

45%

60%

75%

mar

ket c

ondi

tions

atra

ctiv

e fe

atur

es

cons

train

t

good

sig

nal

inve

stor

bas

e

C: Major uses of the funds from convertibles

0%

10%

20%

30%

40%

refin

anci

ng

capi

tal b

udge

ting

cons

train

t

acqu

isiti

on

grow

th o

ppor

t.

D: Net benefits of convertibles relative to alternatives considered

0%

10%

20%

30%

40%

50%

60%

Signif icantlypositive

Marginallypositive

Neutral Marginallynegative

Signif icantlynegative

33

Table 4

Survey response to the question: How has your decision to issue convertibles been affected by market conditions?

Yes No Small Large Growth Non-G Yes No Yes No Low High Normal Special <=50% >50%

2) Stock market volatility was high 66.67 2.59 2.64 2.54 2.85 2.46 3.00 2.63 2.90 1.60*** 2.41 3.13 2.11 2.93* 3.08 1.82*** 2.70 2.63

1) Interest rates were low 53.37 2.61 2.71 2.50 2.86 2.23 3.10 2.38 2.59 2.40 2.53 3.11 2.60 2.57 3.00 2** 2.55 2.56

5) Our stock price was currently high and with convertibles we locked in a favourable premium 38.46 1.81 2.21 1.33 1.33 2.38 1.88 1.75 1.75 2.40 1.76 2.00 0.89 2.46 1.58 2.27 1.89 1.88

4) Our stock was currently undervalued and issuing convertibles was a better choice

34.62 1.81 1.77 1.85 2.08 1.50 2.33 1.63 2.00 1.00 2.06 1.22 1.90 1.83 1.85 1.60 1.70 1.87

6) The convertible debt market in our country is well organized and highly liquid

33.33 2.11 2.54 1.71** 2.14 2.00 2.10 2.00 1.95 2.60 2.38 1.89 2.10 2.00 1.79 2.20 1.64 2.40**

3) We could not issue new debt or shares (because of market conditions, legal constraints, etc.) 23.08 1.35 1.31 1.38 1.38 1.17 1.00 0.75 1.35 1.00 1.81 0.38 1.22 1.31 1.46 1.40 1.40 1.20

P/E

Respondents are asked to rate factors on a scale of 0 (not important) to 4 (very important). We report the overall mean as well as the % of respondents that answered 3 and 4 (very important). ***,**,* denotes a significant difference as the 1%, 5%, and 10% level, respectively. The differences in means based on selected firm and issue specific variables are also reported. These include: France (whether the firm is a French firm), Size (largefirms have market capitalization of at least of 5 billion euros), P/E (growth firms have P/E ratio greater than 14), Dividend (whether the firm pays dividend or not), Trigger (whether the convertibles contain a trigger clauseto force conversion), Nissue (high is firms with more than two convertible issues outstanding), Use of funds (normal uses are for refinancing and capital budgeting purposes, special are for other purposes such asacquistions), and foreign sales (whether firm's foreign sales are greater than 50% of total sales).

Use of funds Foreign salesNissue% Important or very

importantMean

Dividend TriggerFrance Size

34

Fig. 3. Major holders of convertibles and market reaction at the time of issue

A: Market reaction to convertible issue

0%

20%

40%

60%

80%

Negative Positive No impact

B: Major holders of convertibles

0%

20%

40%

60%

80%

100%

Institutionalinvestors

Hedge funds Banks Privateplacement

Others

Average holding (%) Holders (%)

35

Table 5

Survey response to the question: What factors are important in determining your conversion policy?

Yes No Small Large Growth Non-G Yes No Yes No Low High Normal Special <=50% >50%

1) Forcing the conversion would impact significantly the EPS 32.00 1.92 2.08 1.75 1.38 2.55*** 2.00 2.13 1.90 2.00 1.82 2.00 1.43 2.29 1.85 2.22 1.60 2.14

6) Conversion of the issue is not important to us 31.58 2.05 2.00 2.09 2.00 2.14 2.00 2.33 1.93 2.50 2.00 2.13 2.14 1.89 1.64 2.50 2.27 1.75

5) Forcing the conversion would be done as and when future investment opportunities occur 27.78 1.44 2.00 1.09 1.58 1.17 1.86 0.67* 1.47 1.33 1.30 1.57 0.83 1.78 1.64 1.60 1.90 0.88*

3) Forcing the conversion close to the call premium would be unpopular with the investors 9.09 1.14 0.80 1.42 0.92 1.40 1.25 1.00 1.22 0.75 0.79 1.71** 1.33 1.08 1.42 0.86 1.20 1.08

2) Forcing the conversion would mean loss of tax deductibility of interest 8.33 1.13 0.83 1.42 1.08 1.20 1.00 1.86* 1.26 0.50 0.94 1.57 1.43 1.15 1.25 1.00 1.30 1.00

4) Forcing the conversion indirectly through raising dividend is better 0.00 0.86 0.70 1.00 1.00 0.70 1.00 1.00 0.89 0.75 0.64 1.43** 1.33 0.67* 1.25 0.43** 0.90 0.83

Respondents are asked to rate factors on a scale of 0 (not important) to 4 (very important). We report the overall mean as well as the % of respondents that answered 3 and 4 (very important). ***,**,* denotes asignificant difference as the 1%, 5%, and 10% level, respectively. The differences in means based on selected firm and issue specific variables are also reported. These include: France (whether the firm is a Frenchfirm), Size (large firms have market capitalization of at least of 5 billion euros), P/E (growth firms have P/E ratio greater than 14), Dividend (whether the firm pays dividend or not), Trigger (whether theconvertibles contain a trigger clause to force conversion), Nissue (high is firms with more than two convertible issues outstanding), Use of funds (normal uses are for refinancing and capital budgeting purposes,special are for other purposes such as acquistions), and foreign sales (whether firm's foreign sales are greater than 50% of total sales).

P/E% Important or very

importantMean

France Size Use of funds Foreign salesNissueDividend Trigger

36

Fig. 4: Characteristics of convertibles offerings

A: Issue Size (million euros)

0%

10%

20%

30%

40%

50%

60%

<100 100-500 500-1000 >1000

B: Features of the last convertible issued

0%

20%

40%

60%

80%

100%

No Yes No Yes No Yes

Preemptive rights

Trigger clause

Specif ic covenants

C: Issued Debt, Equity or convertible in the last ten years

0%

20%

40%

60%

80%

100%

Issued debt

Issued Convertible

Issued Equity

Yes Yes YesNo No No

D: Number of times convertibles issuedin the last ten years

0%

10%

20%

30%

40%

50%

1 2 3 4 5 6 7

37

Table 6 Survey response to the question: How did you select your investment advisor and what was the major help/advice given by your

investment bank?

Yes No Small Large Growth Non-G Yes No Yes No Low High Normal Special <=50% >50%

1) We had very good relationships with the investment bank that advised us 76.92 3.04 2.75 3.29* 3.29 2.82 2.75 3.22 3.05 3.20 3.06 2.88 3.22 2.92 3.27 2.78 3.10 3.07

3) We have chosen the investment bank that was the most famous convertible specialist (reputation) 65.38 2.65 2.67 2.64 2.86 2.45 2.63 2.78 2.75 2.40 2.75 2.38 2.67 2.62 2.60 2.56 2.70 2.67

6) The investment bank has advised us to issue convertibles because of favourable market conditions 58.33 2.50 2.64 2.38 3.00 1.8*** 2.00 2.33 2.33 3.00 2.73 2.00 2.75 2.17 2.50 2.50 2.50 2.46

8) The investment bank has helped us in pricing and designing the convertibles (call policy, etc.) 56.00 2.68 2.50 2.85 3.08 2.27** 2.43 2.89 2.63 3.00 2.69 2.57 3.00 2.46 2.86 2.56 2.90 2.57

2) We have selected as adviser a bank that was also able to finance us (lending money) 46.15 2.12 2.75 1.57** 2.00 2.27 1.75 2.00 2.05 2.40 2.63 1.38** 1.67 2.31 2.00 2.22 1.40 2.60**

4) We have chosen our investment bank for pricing issues (the bank that offered the best pricing) 38.46 2.19 2.08 2.29 1.86 2.45 2.25 1.78 2.10 2.20 2.06 2.38 2.00 2.23 2.20 2.22 2.20 2.07

9) The investment bank has helped us in evaluating other alternative securities versus convertibles 28.00 1.72 1.42 2.00 2.00 1.18* 1.00 2.11** 1.47 2.20 1.81 1.57 2.25 1.38* 1.57 2.11 1.70 1.57

5) We have chosen our investment bank for fees conditions (low fees) 26.92 2.04 1.83 2.21 1.79 2.18 2.25 1.89 1.95 2.00 1.81 2.50 2.33 1.77 2.13 1.89 1.90 2.00

7) The investment bank has explained to us the advantages of convertibles and has influenced us 12.5 1.63 1.45 1.77 2.08 1*** 1.14 1.89 1.39 2.40** 1.53 1.43 2.25 1.17** 1.93 1.25 1.40 1.77

Nissue

Respondents are asked to rate factors on a scale of 0 (not important) to 4 (very important). We report the overall mean as well as the % of respondents that answered 3 and 4 (very important). ***,**,* denotes a significant difference as the1%, 5%, and 10% level, respectively. The differences in means based on selected firm and issue specific variables are also reported. These include: France (whether the firm is a French firm), Size (large firms have market capitalization of atleast of 5 billion euros), P/E (growth firms have P/E ratio greater than 14), Dividend (whether the firm pays dividend or not), Trigger (whether the convertibles contain a trigger clause to force conversion), Nissue (high is firms with more thantwo convertible issues outstanding), Use of funds (normal uses are for refinancing and capital budgeting purposes, special are for other purposes such as acquistions), and foreign sales (whether firm's foreign sales are greater than 50% of totalsales).

% Important or very

importantMean

P/E Dividend Use of funds Foreign salesFrance Size Trigger

38

Table 7 Spearman correlations between survey responses and issuer and offering characteristics

Delay Equi.

Avd. EPS

Callability

Risk Unc.

BV D/E

Less Exp.

Tax Adv.

No Rat.

Less Cov.

Intl. Inv.

Fut. Fin.

Signal Debt Equi. Low Rate

High Volt.

Can't Issue

Und Val.

Over Val.

MkLiq Imp. EPS

Invt Opp

Not Imp France Size P/E Divd. Trig. Nis. Use funds

FRN sales

Net Ben.

Panel A

Avoid EPS 0.49***

Callability 0.16 0.24

Risk Unc. 0.06 0.15 0.36*

BV D/E 0.02 -0.06 0.40** 0.33*

Less Exp. 0.02 0.14 0.39** 0.19 -0.08

Tax Adv. -0.11 0.31 0.31* 0.24 0.54*** -0.11

No Rating -0.05 -0.08 0.35* 0.11 0.07 0.33* -0.33*

Less Covn. 0.08 0.08 0.47*** 0.05 0.09 0.39** -0.05 0.71***

Intl. Invest. 0.19 0.48*** 0.59*** 0.29 0.22 0.26 0.19 0.36* 0.31*

Fut. Fin. 0.37* 0.07 0.30* -0.22 0.42** -0.05 0.09 0.18 0.16 0.42**

Signal 0.17 0.43** -0.08 -0.29 -0.03 0.06 0.21 -0.35* -0.15 0.16 0.28

Debt -0.40** -0.20 -0.01 -0.16 -0.24 -0.02 -0.15 0.12 0.14 0.23 0.03 -0.06

Equity 0.21 0.20 -0.09 0.24 0.03 0.02 0.35* -0.17 -0.11 0.00 -0.17 0.10 -0.24

Low Rate 0.01 0.05 0.24 -0.17 0.10 0.52*** -0.13 0.14 0.08 0.26 0.11 0.18 0.24 -0.16

High Volt. 0.01 0.28 -0.01 -0.10 -0.41** 0.19 -0.30 -0.06 -0.06 0.34* 0.03 0.22 0.39** -0.32 0.42**

Cannot Issue -0.04 0.08 0.16 -0.03 0.06 0.09 0.00 0.60*** 0.62*** 0.10 -0.08 -0.19 0.18 0.16 -0.05 -0.11

Under Val. -0.05 0.11 0.14 0.50*** 0.09 0.22 0.12 0.15 0.17 0.02 -0.44** -0.17 -0.29 0.42** 0.04 -0.13 0.22

Over Val. 0.54*** 0.24 0.08 -0.10 -0.10 -0.01 -0.16 -0.11 0.12 -0.11 0.12 -0.05 -0.21 -0.05 -0.08 0.03 -0.06 -0.25

MkLiq 0.13 -0.22 0.10 -0.06 0.00 0.41** -0.38* 0.43** 0.50*** -0.15 -0.04 -0.16 -0.25 -0.19 0.15 0.00 0.32 0.12 0.26

ImpctEPS 0.19 0.23 -0.19 -0.12 -0.13 0.05 0.20 -0.31 0.02 -0.32 -0.01 0.03 -0.07 0.16 0.02 0.02 -0.15 -0.02 0.54*** -0.07

InvtOpp 0.22 0.29 0.24 0.30 -0.19 0.31 -0.37 0.31 0.42* 0.38 0.04 -0.03 0.44* 0.00 0.24 0.33 0.12 -0.02 0.32 -0.08 0.30

Not Imp 0.29 -0.13 -0.31 -0.24 0.06 -0.56** -0.11 -0.11 -0.39 -0.23 0.13 0.03 -0.34 -0.10 -0.32 -0.23 -0.02 -0.36 0.12 0.24 -0.37 -0.36

Panel BFrance 0.60*** 0.19 0.14 -0.07 -0.25 0.50*** -0.46*** 0.21 0.28 -0.08 0.21 0.11 -0.28 -0.04 0.09 0.08 -0.01 -0.06 0.29 0.39** 0.09 0.31 -0.04

Size 0.15 -0.03 -0.39** -0.23 -0.08 -0.24 -0.06 -0.42** -0.56*** 0.53*** 0.03 -0.06 -0.24 0.07 -0.16 0.00 -0.11 -0.17 0.35* -0.15 0.36* -0.32 0.34 0.08

P/E -0.12 -0.35 -0.19 0.17 0.01 0.18 -0.59*** 0.16 0.06 -0.07 -0.07 -0.10 0.09 0.01 0.29 0.26 0.14 0.31 0.03 0.23 0.02 0.61** -0.21 0.03 0.06

Divd. 0.02 0.26 -0.30 0.09 -0.22 -0.15 -0.10 -0.12 -0.17 0.01 -0.32* -0.02 0.18 0.28 0.03 0.41** 0.09 0.30 -0.18 -0.30* -0.02 -0.01 -0.17 -0.04 0.19 0.04

Trigger 0.08 0.21 0.17 0.15 0.02 0.21 0.16 0.51*** 0.52*** -0.10 -0.07 -0.13 -0.21 0.45** -0.30 -0.41** 0.59*** 0.30 -0.07 0.25 -0.05 -0.11 -0.06 0.30 -0.13 -0.35 0.04

Nissue 0.36* 0.41** -0.12 -0.15 -0.29 -0.01 0.00 0.03 0.14 0.03 0.15 0.20 0.05 0.37* -0.13 0.22 0.22 -0.21 0.47** 0.08 0.26 -0.10 0.20 0.23 0.22 -0.10 0.39* 0.46**

Use of funds 0.26 -0.04 -0.06 -0.02 0.15 -0.09 0.11 -0.45** -0.33* -0.34* 0.10 0.31 -0.53*** 0.45** -0.33 -0.45** -0.27 -0.15 0.26 0.08 0.00 -0.22 0.45* 0.26 0.34* 0.13 -0.16 0.04 0.15

FRN sales -0.16 -0.32* 0.13 -0.23 0.10 0.15 0.06 0.14 0.38** -0.27 0.20 -0.04 -0.13 -0.22 0.02 0.01 0.11 0.09 -0.09 0.35* 0.17 -0.35 -0.30 0.15 0.02 0.00 -0.20 0.30 -0.02 -0.08

NetBenefits 0.26 0.37** 0.27 -0.10 -0.02 0.06 0.30 0.03 0.32* 0.27 0.15 0.22 0.12 0.33 -0.01 0.17 0.13 -0.13 0.16 -0.11 0.33 0.16 -0.21 0.07 -0.16 -0.44* 0.27 0.33* 0.53*** -0.09 0.12

Mkt.Reaction 0.21 -0.15 -0.42* -0.22 -0.38 -0.36 -0.41* 0.03 -0.14 -0.34 -0.17 -0.44* 0.19 0.34 -0.05 -0.09 -0.03 -0.07 0.51** -0.12 0.40* 0.36 0.06 0.06 0.43* 0.16 0.50** -0.01 0.31 0.09 -0.30 0.11

Spearman correlations between survey responses are reported. ***, **, * denote significant difference in means (medians) at the 1%, 5%, and 10% levels, respectively.

Over Val. (stock price was currently high and convertibles locked in a favourable premium), MkLiq (convertible debt market is well organized and highly liquid), ImpctEPS (conversion would impact significantly the EPS), InvtOpp (conversion would be done as and when futureinvestment opportunities occur), Not Imp (Conversion of the issue is not important to the issuing firm).

Factors in conversion policy (Table 5)

Panel B: France (whether the firm is a French firm), Size ( market capitalization in million euros), P/E (Average price to earning ratio for last 3 years), Divd. (whether the firm pays dividend or not), Trigger (whether the convertibles contain a trigger clause to force conversion), Nissue(number of issues outstanding), Use of funds (normal uses are (1) refinancing, and (2) capital budgeting, special are (3) distress situation, (4) acquistions, and (5) growth), FRN sales (whether firm's foreign sales are greater than 50% of total sales), NetBenefits (net benefits ofconvertibles rated from significantly negative to significantly positive), and Mkt.Reaction (approximate % impact on stock price when convertibles were issued).

Panel A: Delay Equity (Convertibles are issued as "delayed equity" financing expecting that the debt would be converted), Avoid EPS (issuing convertibles avoided Short-term Equity Dilution (SED), Callability (Convertibles gave the ability to "call" or force conversion of debt), RiskUnc. (Convertibles allowed to attract investors unsure about the risk of the firm), BV D/E (Issuing convertibles increased the book value of equity/debt ratio), Less Exp. (Convertibles were less expensive than debt), Tax Adv. (Convertibles induced tax advantage of interest deductibility),No Rating (Convertible funding did not require a rating), Less Covn. (Convertible could be issued with less covenants than “classical” bonds), Intl. Invest. (Compared with debt, convertibles gave the ability to reach international investors), Future Fin. (Convertibles provides flexibility infinancing uncertain future investments), Signal (Convertibles provide a good signal to the market about future growth opportunities), Debt (Straight debt-non convertible), Equity (Common stock), Low Rate (Interest rates were low) High Volt. (Stock market volatility was high), CannotIssue (could not issue new debt or shares), Under Val. (stock was currently undervalued and issuing convertibles was a better choice),

Market conditions (Table 4)

Firm and offering characteristics (Tables 3-6)Alternatives (Fig.2A)

Factors affecting firm's decision about issuance of convertibles (Table 3)

39

Appendix 1: Summary of the relation between Survey evidence and factors influencing Convertible bond issuance A theoretical concept or factor is listed in the first column, followed by its empirical implications (second column), the direct survey evidence (column 3), and any additional evidence in column 4. √ (x) indicates whether the survey evidence supports (does not support) the idea in the first column.

Survey evidence (Direct) OTheory or Concept Empirical Implications(Tables 3-6, Figures 1-4)

ther Survey Evidence Correlation Analysis (Table 7)

I. Rationale for convertible IssuanceA. Risk based Models1. Uncertainty about Risk (Brennan and Schwartz (1988) Main Features / Assumptions: Implications:

1. To attract investors “unsure” of risk √ Attract investors unsure of risk (21%, Table 3) Firms issuing convertibles to attract investors unsure of risk: √ tend to have undervalued stock (Corr.= 0.50***) x tend to value flexibility of callability (Corr.=0.36*)

2. Alternative to debt issue √ Alternative to debt issue (70%, Figure 2)

3. Firm characteristics- High growth firms √ High growth firms (55% P/E >14, Figure 2)- Industries with High Earnings Volatility x Other industry peers use convertibles (14%, Table 3)

4. Call provision √ Conversion is not important (32%, Table 5)- Not important x Ability to “call” important (28%, Table 3)

1. To attract investors “unsure” of risk x Attract investors unsure of risk (21%, Table 3)

2. Convertible debt used as a signal √ Good signal about growth opportunities (55%, Table 3)3. 'Risk' conveyed by varying features √ Large cross-sectional variation in convertible features across

firms √ Firms that use convertibles as signal tend to have less negative stock price reaction (Corr.= -0.44*)

Main Features / Assumptions: Implications:

2. Alternative to debt √ Alternative to debt issue (70%, Figure 2)3. Less expensive than debt √ Convertible are less expensive than debt (72%, Table 3)

4. Call provision √ Conversion is not important (32%, Table 5)- Not important

x Ability to “call” important (28%, Table 3)B. Asymmetric Information Framework1. “Backdoor Equity” model (Stein, 1992)Main Features / Assumptions: Implications:

-Uncertainty of risk about assets in place - Solves financing problem at the time of issue

- Uncertainity of risk about assets -asymmetric information framework

- Agency problem between shareholders and bondholders - Concern about Ex-post risk shifting - Convertibles resolve financing and risk incentive problems

2. Brennan and Kraus (1987)

3. Risk –shifting (Green, 1984)

1. Protects bondholders against ex-post risk shifting by shareholders

x Protect bondholders against unfavourable actions of shareholders or managers. (3%, Table 3)

√ Firms considering convertibles as less expensive tend to consider the call provision unimportant (Corr=-0.56**)

40

Appendix 1 (continued) - Asymmetric information abou √ Delayed equity major reason (86%, Table 3)

2. Alternative to an equity issue √ Alternative to equity issue (23%, Figure 2)x Alternative to debt issue (70%, Figure 2)

3. Firm characteristics:- High debt to equity ratio √ Convertibles increase book value of equity/debt (21%, Table 3) x Firms issuing convertibles as "delayed equity" have low

correlation with firms issuing convertibles to increase equity/debt ratio (Corr. = 0.02)

- Low or distressed equity value √ Stock undervalued (35%, Table 4) √ Firms issuing convertibles as alternative to equity issue tend to have undervalued stock (Corr.= 0.42**)

x Stock overvalued (38%, Table 4) x Firms issuing convertibles as “delayed equity” are more likely to have overvalued stock. (Corr.=0.54***)

- Debt constraints x Debt or other constraints (15%, Figure 4) x Low correlation between firms issuing convertibles as "delayed equity" and firms that cannot issue (Corr. = -0.04)

4. Call provision √ Trigger clause (65%, Figure 4)- Very important √ Flexibility provided by “call” (28%, Table 5)

√ Ability to “call” important (28%, Table 3) x Firms citing "Delayed equity" also tend to consider call unimportant (Corr.= 0.29)

x Conversion is not important (32%, Table 5)5. Market reaction

- Negative but less negative than an equity issue

√ Market reaction negative (64%, Figure 3)

2. Constantinides and Grundy (1989)Main Features / Assumptions: Implications:

2. Firm characteristics - High debt to equity ratio after issue x Increase book value of equity/debt (21%, Table 3)

3. Call provision- Not important √ Conversion is not important (32%, Table 5)

x Ability to “call” important (28%, Table 3)3. Sequential-Financing (Mayers, 1998)Main Features / Assumptions: Implications:

1. Solves future financing problem √ Financing uncertain future investments (18%, Table 3)√ Forcing the conversion when future investment opportunities arise (28%, Table 5)

x Firms issuing convertibles to finance future opportunities do not set their conversion policy accordingly (Corr. =-0.03)

x Few cite use of funds for future growth opportunities ( 12%, Figure 2)

x Use of funds primarily for refinancing and capital budgeting (57%, Figure 2), none for stock repurchase

√ Firms issuing convertibles as “delayed equity” are less likely to consider debt (Corr.= -.40**) and more likely to consider equity (Corr. = 0.21) as alternative

- Overcomes asymmetric information problem - Separating equilibrium and efficient investments

1. Convertible issue combined with repurchase of stock

t assets in place - Solves a financing problem at the time of issue - Firms wish to issue equity but are unable to do so. - Financial distress costly

1. Backdoor equity - Issuer optimistic about conversion

- Uncertainty about the value of future investment opportunities - Solves problems of financing profitable future investment options - Resolves incentive conflict regarding over investment (free-cash–flow) problem and reduces issuing costs - Assumes costly to issue securities

41

Appendix 1 (continued) √ Good signal about growth opportunities (55%, Table 3) √ Firms issuing convertible to finance future opportunities

tend to also use it as a signal (Corr. = 0.29)

3. Alternative to debt √ Alternative to debt issue (70%, Figure 2)4. Firm characteristics:

- High growth firms √ High growth firms (55% P/E >14, Figure 2) √ High growth firms plan their conversion policy to finance future growth opportunities (Corr. = 0.61**)

5. Call feature - Very important √ Ability to “call” important (28%, Table 3)

x Conversion is not important (32%, Table 5)√ Flexibility provided by “call” (28%, Table 5)√ Trigger Clause (65%, Figure 4) x Firms issuing convertibles to finance future opportunities

may not necessarily have a trigger clause (Corr. = -0.07)

√ High stock price (38%, Table 4)x Low stock price (35%, Table 4)

7. Economies on issue costs. √ Less expensive than debt (72%, Table 3) x Firms considering convertibles as less expensive tend to consider the call provision important (Corr=-0.56**) as well as callability important (Corr. =0.39**)

II. Other FactorsA. Theory and Practice of Capital Structure 1. Theoretical models - Asymmetric information framework √ Negative market reaction (64%, Figure 3) √ Firms perceive postive net benefits of convertible

issuance despite negative stock price reaction (Corr.= 0.11)

- Pecking-order theory - Signaling theory √ Good signal about growth opportunities (55%, Table 3)

2. “Window of opportunity” √ High Stock market volatility (67%, Table 4)√ Low Interest rate (53%, Table 4)

√ Stock overvalued (38%, Table 4)

√ Stock undervalued (35%, Table 4)3. Managerial Beliefs

- Less expensive √ Convertible are less expensive than debt (72%, Table 4)- EPS dilution √ Convertibles avoid short-term equity dilution (48%, Table 3)

√ Forcing the conversion would affect EPS (32%, Table 5)√ Firms with overvalued stocks tend to issue convertibles as “delayed equity” (Corr.=0.54***) and to avoid EPS dilution (Corr.=0.24)

√ Forcing the conversion would affect EPS (32%, Table 5) √ Frequent users tend to avoid short-term equity dilution (Corr. = 0.41**)

- Book Value of Debt to Equity ratio √ Convertibles increase book value of equity to debt (21%, Table 3)

√ Flexibility of callability provision important for financing uncertain future invtestments (Corr.=0.30*)

6. Equity value could be overvalued / undervalued

- Market conditons influence issuance decision(Table 4) √ Low interest rates and high stock volatility provide good

window of opportunity (Corr. = 0.42**)

√ Firms that use convertibles as signal tend to have less negative stock price reaction (Corr.= -0.44*)

2. Provides signal about firm's growth opportunities

42

43

Appendix 1 (continued) B. Demand and Supply factors

-Increased demand by institutional investors

√ Institutional investors are major holders of bonds (86%, Figure 3)

-Increased demand by Hedge funds √ Hedge funds are major holders of bonds (55%, Figure 3)- Increase in Merger and acquisitions activity

√ 23% convertibles issued for mergers and acquisitions (Figure 2)

- Well organised √ Well organised and liquid market (33%, Table 4) √ Managers who consider convertibles as less expensive are likely to value the well organised and liquid market. (Corr. = 0.41**)

- Participation by international investors √ Convertibles facilitate reaching international investors (18%, Table 3)

3. Appeal to different firms - Design of convertibles can be adjusted to fit the needs of different firms

√ Large variation in motivations of convertible issuance (Table 3) √ Small Firms highly value access to international investors (Corr=-0.53***) and less covenants (Corr. =-0.56***); large firms tend tend to have overvalued stock (Corr. = 0.35*) and are more concerned about EPS dilution at conversion (Corr. =0.36*)

√ Large variation in convertible features such as call premium, maturity, etc. (Figure 4)√ Features of convertibles are the primary reason for issuance (Figure 2)

√Firms perceive postive net benefits of convertible issuance despite negative stock price reaction (Corr.= 0.11)

√ Frequent users (96% , Figure 4)

4. Role of Investment Bankers

5. Country-specific factors -France versus other countries

√ French firms tend to state that convertibles are less expensive than debt compared to other firms (Table 3)

2. Development of European Convertible market (Noddings et al. (2001))

1. Demand of Convertibles (Noddings et al. (2001))

√ Investment advisor helps in designing (56%, Table 6), especially for smaller firms

-Investment bankers help in designing and pricing

√ French firms issue convertibles both as "delayed equity" (Corr. =0.60***) and consider it less expensive (Corr. = 0.50*** , and value well organized market for convertible in their country (Corr. =0.39**).

√ Frequent users tend to perceive net benefits as signficantly positive (Corr. = 0.53***)

√ Investment advisor advise about market conditions ( 58%, Table 6) especially for small firms