The usage of convertible and warrant bonds by Japanese firms: Risk-shifting or the delayed issuance of equity?

This paper examines the risk-shifting and delayed equity hypotheses concerning the use of convertible securities by Japanese firms. The popularity of equity-linked debt instruments in Japan where institutional arrangements can mitigate the transfer wealth from bondholders to stockholders appears inconsistent with the risk-shifting hypothesis. Further, we find that the probability of selecting convertible securities over common equity is not positively related to the potential for a wealth transfer from bondholders to stockholders. We obtain similar results when we examine convertible debt ratios. However, we find evidence consistent with the delayed equity hypothesis that firms use convertibles to delay equity when they have favorable information about the firm. The stock price increases preceding and following convertible issuance are positively related to offering size and growth opportunities as predicted by the delayed equity hypothesis. Overall, our findings endorse the delayed-equity hypothesis as an explanation for the use of convertible securities by Japanese firms.