Convertible bond maturity and debt overhang

Gan, Liu and Xia, Xin and Xu, Wenyang and Zhang, Hai (2024) Convertible bond maturity and debt overhang. International Review of Financial Analysis, 95 (Pt. B). 103410. ISSN 1057-5219 (https://doi.org/10.1016/j.irfa.2024.103410)

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Abstract

We develop a dynamic corporate investment model to investigate the determinants of the optimal maturity structure of convertible bonds and its debt overhang effect. Our model predicts that relative to the issuance of straight bonds, companies opting for short-term (long-term) convertible bonds tend to expedite (delay) their investment activities, thereby alleviating (exacerbating) issues related to underinvestment. This outcome provides a theoretical rationale for the observed trend of decreasing convertible bond maturity, as explained by debt overhang theory. Moreover, contrary to previous findings, a growth company optimally chooses to issue convertibles with shorter maturities when it has fewer valuable growth opportunities. These insights improve our understanding of the interactions between convertible bond maturity and corporate investment.

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