Signaling with convertible debt in the renewable energy industry?

Purpose – The purpose of this paper is to show how convertible debt is used in the renewable energy industry. The authors argue that there is an investor rationing component to the design and market impact of convertible debt securities. Design/methodology/approach – The authors apply event study methodology, option pricing theory and risk shift analysis to examine capital market reactions following the issuance of convertible debt by exchange-listed companies of the renewable energy sector. Findings – Contrary to prior cross-industry research findings, the authors show that convertible debt in the renewable energy industry tends to have a debt-like structure, and its issue is associated with strongly negative announcement returns. The authors further show that convertible issuers face high business risk and adverse selection costs. Practical implications – The results have important implications for both renewable energy industry companies and investors. For example, one problem is that the risk-mitigating features of convertible debt may not materialize, if issuers fail to credibly signal firm quality to the markets. Furthermore, excessive growth assumptions and mismatches between project risk/return and financing costs may render it more difficult to create credible signals. Originality/value – The paper contributes to three primary strands of literature. One is the research on finance and growth. Here, this paper provides new insights into risk-mitigating securities that should more effectively mirror the risk and return distributions of emerging industry issuers. Additionally, it extends the research on the motives for convertible debt offerings and provides insight on stock returns around such announcements.