Agency Effects in the Convertible Debt Puzzle: An Empirical Investigation

We suggest that the symmetry of stock price reactions observed to the issuance and subsequent redemption of convertible bonds can be partially explained by agency effects. Using a hand collected dataset we test whether the heterogeneity in cumulative abnormal returns at these two corporate event dates can be explained by agency problems. Our results confirm there exists heterogeneity in the observed negative stock market returns at these dates that are related to proxies for agency problems (between firm management and stockholder). Similarly, upon redemption, we find that forced conversion is more likely to happen in firms more likely to suffer from agency conflicts and in low value firms, which explains the negative stock market reaction at that date. Finally, we find that call redemptions of out-of-the money bonds experience a positive stock price reaction contrasting with the negative reaction seen for in-the-money bond calls which further supports the agency problems story.