Two Essays on Convertible Debt

This dissertation examines two different topics relatedto the issuance of a convertible debt security. The firstessay addresses the question of how managers set theequity value in a convertible debt issue. A convertibledebt security has value derived from an equitycomponent and a debt component. As a result,managers must decide how much of the convertibledebt's value will be derived from equity at issuance. Iexamine three hypotheses in addressing this question.Empirical evidence is provided supporting theassertion that managers issue more equity-like debtwhen the firm will have lower future operatingperformance and a greater potential forunderinvestment. Empirical support is not found formanagers take into consideration asset substitutionconcerns when setting the equity value in a convertibledebt issue. The second essay examines why areabnormal returns negative for the equity during theconvertible debt's issuance period. This has beendocumented by Dann and Mikkelson (1984),Mikkelson and Partch (1986, 1988), and also by thisdissertation. I furnish evidence that is consistent with abid-ask spread bias not causing the negative equityabnormal returns during the issuance period of aconvertible debt security. Tests are also performedthat provide results that are consistent with the issueperiod returns being partially due to a resolution ofuncertainty.