Mandatory Convertibles and Shareholders Incentives

Abstract

A relative large proportion of the academic literature about the agency dilemma studies corporate governance or the instruments that can balance the incentives of shareholders and debt holders. This article studies a balance sheet instrument, the mandatory convertible bond, as a means to increase the value for shareholders, without reducing the bondholders claim. Following the options valuations theories, one way to increase the value for shareholders is to increase the risk of the firm that in turn reduces the value for bondholders. The results show that after the issuance of mandatory convertible bonds, companies reduce the return required by bondholders and at the same time increase its equity volatility and the potential shareholder value.