Covenants in convertible bonds: Boon or boilerplate?

This paper examines the role of restrictive covenants in convertible bonds. After controlling for standard covenant intensity determinants, an average convertible bond offering has 3.21 fewer covenants than an average straight bond offering. While covenants negatively affect straight bond yields, there is no negative association between covenants and convertible bond yields. Moreover, contrary to straight bond covenants, convertible bond covenants are set largely independently of issuer characteristics. Overall, our findings suggest that the conversion option and certain covenants are substitutes for addressing debt-related financing costs. The few covenants included in convertibles represent irrelevant boilerplate clauses.     

Contingent Capital vs. Contingent Reverse Convertibles for Banks and Insurance Companies

During the credit and liquidity crisis in 2007 and 2008, banks found themselves largely unable to raise significant new equity quickly from parties other than sovereign wealth funds and governments. Some banks have thus recently begun to consider contingent capital as a means of pre‐arranging recapitalizations for future crises. Contingent capital is a type of put option that entitles a company to issue new securities on pre‐negotiated terms, often following the occurrence of one or more risk‐based triggering events. This article compares the economic merits of a new security—a “contingent reverse convertible” or CRC—against more traditional forms of contingent capital. In November 2009, Lloyds Banking Group plc issued “Enhanced Capital Notes”—subordinated debt that converts into common stock if Lloyds's core regulatory capital falls below 5% of its regulatory risk‐weigh ted assets. This CRC is not strictly speaking a form of contingent capital, but it does give banks the potential to recapitalize themselves quickly in the face of a crisis without having to turn to governments and taxpayers. One important limitation of CRCs is that because they do not generate new cash for a bank at the time of conversion, they are unlikely to stop a liquidity crisis once it has begun. More traditional contingent capital facilities, by contrast, do put cash in the hands of the issuer at the time the facility is drawn. But even for those inclined to use CRCs, it may be unrealistic to expect many other institutions to imitate the structure of the Lloyds offering. Persuading existing investors to take a more subordinated position in a bank's capital structure and write a put option to the bank on its own stock will be neither cheap nor easy. For this reason, the more traditional solutions used to date may have more success with banks, though arriving at a price that helps issuers and satisfies investors will be a challenge for those structures as well.     

Customers' perceptions on the dispute resolution clauses in Islamic finance contracts in Malaysia

This empirical legal study examines the perceptions of retail customers on the dispute resolution clauses contained in the governing law and jurisdiction clauses in Islamic finance contracts in Malaysia. Since Islamic financial institutions and their customers are more likely to opt for litigation in the event of a dispute, this study explores ways of providing for unambiguous dispute resolution clauses that are well understood by the parties. Such clauses are expected to incorporate effective dispute resolution processes such as mediation and arbitration through a multi-tiered mechanism. Primary data collected through survey questionnaire administered on 160 Islamic bank customers is analysed using both factor analysis and structural equation modelling. The empirical legal study reveals that there is a statistically significant direct effect of dispute resolution clauses in Islamic finance contracts on the legal awareness and understanding of the customers and indirect effect on the customers' dispute resolution channels. It therefore follows that there is a need to provide for more effective clauses that allow for mediation and arbitration in the governing law and jurisdiction clauses of Islamic finance contracts in Malaysia. Such alternative dispute resolution processes can be structured in a multi-tiered manner that will only allow for litigation as a last resort. This will allow Islamic financial institutions and their customers to make informed decisions about the best option for effective dispute management.     

Earnings Management and the Long-Run Underperformance of Firms Following Convertible Bond Offers

Abstract:  This paper examines whether the long-run underperformance of convertible bond issuers can be explained by earnings management, as reflected in discretionary current accruals around the time of the offer. Consistent with the earnings management hypothesis, we find that convertible issuers who adjust their discretionary current accruals to report higher net income in the issue year will generally experience inferior operating and stock return performance over the five-year post-issue period. Our findings indicate that there is some temporary overvaluation of convertible issuers by the stock market, but that the resultant disappointed investors will subsequently correct their valuation errors. The similarity of our results to those reported within the prior literature on initial public offers (IPOs) and seasoned equity offers (SEOs) suggests that the earnings management hypothesis is not unique to stock offers, but that it actually extends to convertible bond offers.     

THE CHOICE AMONG DEBT,EQUITY, AND CONVERTIBLE BONDS

The hybrid nature of convertible bonds continues to interest corporate financial managers, investors, and economists. While much theoretical and empirical research examines an issuer's choice between using straight debt and equity, little research evaluates how an issuer chooses among debt, equity, and convertible bonds. This study extends Marsh's [ 13 ] research on the differences between debt and equity issuers in the United Kingdom by examining U.S. industrial firms that issue debt, equity, or convertible bonds. It also illustrates how various distinguishing features influence the probability that each security will be issued.     

Convertible Debt Issuance and Market Completeness

Recent empirical evidence on option listings supports the notion that equity options help to span the market. This paper investigates the role of convertible debt in market completion. To the extent that the warrant portion of convertible instruments is similar to a call option, the securities can provide payoffs in states of nature that were previously unspanned. Stockholders of firms without listed options or pre-existing warrant-related securities suffer less severe wealth declines around convertible offerings than do owners of firms with contingent claims on their stock. The results suggest that, particularly before the rise of options on index futures, convertible debt played a market-spanning role similar to that of equity options.     

What drives the performance of convertible-bond funds?

This paper examines the performance of US mutual funds that invest primarily in convertible bonds. Multivariate cross-sectional analyses show a significant relation between a fund’s performance and its asset composition: the higher the difference in the percentage of assets invested in convertible bonds compared to the percentage invested in stocks, the higher the performance, on average. We show that this result can be explained by factors associated with investment opportunities in the convertible-bond market and trading strategies related to convertible arbitrage, as typically performed by hedge funds. Overall, convertible-bond fund performance measured by alpha is comparable to a passive investment in stocks, bonds, and convertible bonds. This performance is the result of weak selection skills and successful timing strategies related to convertible arbitrage.     

银行背景董事与可转债融资: 中国的证据

基于我国的金融环境,将银行背景董事的来源分为五大行和非五大行两种类型,以此考察不同来源的银行背景董事对可转债融资的影响是否存在差异。研究发现：来自五大行的银行背景董事对可转债融资申请是否被证监会审核通过不会产生显著影响,而来自非五大行的银行背景董事具有显著的正面影响,但是,在可转债融资后的经营业绩上,两者都不会产生显著的积极影响。这表明银行背景董事的作用,主要来自于非五大行的银行背景董事,并且,发挥的作用有限,仅体现了其咨询功能,而非监督功能。     

Why Do Western European Firms Issue Convertibles Instead of Straight Debt or Equity?

Unlike their US counterparts, European convertible debt issuers tend to be large companies with small debt‐ and equity‐related financing costs. Therefore, it is puzzling why these firms issue convertibles instead of standard financing instruments. This paper examines European convertible debt issuer motivations by estimating a security choice model that incorporates convertibles, straight debt, and equity. We find that European convertibles are used as sweetened debt, not as delayed equity. This motivation is reflected in the debt‐like design of most European convertible issues.     

Investment in internet banking as a real option: theory and tests

This paper examines the optimal exercise of strategic real options to invest in Internet banking (IB) technology within a two-stage game, parameterized by the distribution of bank size and uncertainty over the profitability of investment, and empirically tests the results. The value of the strategic investment option to a strategically significant entrant into IB depends on both expected future profits as well as the variance of those profits. Expected profits to an entrant depend, in equilibrium, on its size, as measured by existing market share (concentration) or total assets, relative to its rivals. Conditional on the degree of uncertainty, larger banks should, as a consequence, exercise their options earlier than smaller banks, for purely strategic advantages, and act as market leaders in the provision of IB services. Like ordinary options, however, the value of the strategic investment option to both large and small banks increases in uncertainty, implying that early exercise will be more likely the more information is available about potential demand. We test these hypotheses on investment in IB services with data from a sample of 1618 commercial banks in the tenth Federal Reserve District during 1999. Consistent with our hypotheses, relative bank size, as measured by measures of concentration, and demographic information predictive of future demand both positively influence the probability of entry into IB in our sample.     

商业银行贷款承诺业务国际比较分析

贷款承诺是国际商业银行的重要表外业务之一,本文系统介绍了贷款承诺使用目的、费率体系、条款设计等特点;论述了贷款承诺产品的供求特性;讨论了贷款承诺理论定价和实际价格影响因素;分析了贷款承诺对银行的风险影响及其规避办法。文末对国内贷款承诺业务现状进行了分析。     

Banks recapitalization policies in Japan and their impact on the market

The following measures to boost banks’ capital were implemented from December 1997 through March 1998 in Japan: (1) Banks were given the option to choose the cost method in the valuation of their equity portfolios. (2) Reevaluation of bank property assets at current market values was introduced. (3) Public funds were injected into the banking system. This article examines whether or not the announcements of these measures have had any impact on stock prices. We find: (1) The announcement of the introduction of the cost method in the valuation of equity portfolios had a limited effect on stock prices. (2) The announcement of reevaluation of property assets had a relatively strong impact on stock prices. (3) The aim of capital injection by the government might be interpreted by investors in general as an attempt to favor weak banks rather than to bolster the capital base of strong banks.     

商业银行实施激励股票期权若干问题研究

近年来,激励股票期权在我国商业银行中逐渐被重视,并即将成为重要的激励方式.本文在阐述商业银行实施激励股票期权重要意义的基础上,指出应合理定位法律在实施激励股票期权过程中充当的角色,法律不宜过多介入商业银行激励股票期权方案的实施,但对激励股票期权实施过程是否公正、实施结果是否合理等情况则应保留相当程度的审查权与裁判权.同时,指出以股价、财务会计手段作为业绩测量标准来界定银行业绩的含义均存在一定缺陷,授予业绩或指数期权而非固定溢价期权应为更佳选择;本文还对激励股票期权的授予数量、持有时间和期权重新定价等问题进行了剖析.     

商业银行实施激励股票期权若干问题研究

近年来,激励股票期权在我国商业银行中逐渐被重视,并即将成为重要的激励方式.本文在阐述商业银行实施激励股票期权重要意义的基础上,指出应合理定位法律在实施激励股票期权过程中充当的角色,法律不宜过多介入商业银行激励股票期权方案的实施,但对激励股票期权实施过程是否公正、实施结果是否合理等情况则应保留相当程度的审查权与裁判权.同时,指出以股价、财务会计手段作为业绩测量标准来界定银行业绩的含义均存在一定缺陷,授予业绩或指数期权而非固定溢价期权应为更佳选择;本文还对激励股票期权的授予数量、持有时间和期权重新定价等问题进行了剖析.     

Accounting for Convertible Loan Stock: A Decomposition Approach

This paper examines the accounting treatment of convertible loan stock (CLS), a popular vehicle for raising finance during the past decade. At present, CLS is treated as part of a company's borrowing with the interest charge thereon deducted in arriving at the pre-tax profit in the profit and loss account. The Technical Committee of the Institute of Chartered Accountants in England and Wales (1987) has proposed that the annual interest charge in the profit and loss account relating to CLS be adjusted so that the charge reflects ‘a fair interest cost’ and that the adjustment be treated in the balance sheet as a ‘payment received for an option’. To date that guidance appears to have been ignored by UK companies. Our approach is different from that of the Technical Committee. We recommend that the accounting treatment of CLS should reflect its economic substance and argue that it be decomposed into two components: a straight bond component and a component which offers the holder an option to convert into equity. The straight bond component should be shown as part of a company's borrowing and the conversion option component as part of the shareholders' funds. The different approaches to accounting for CLS are illustrated by means of a case study.     

可转换债券在公司连续融资中作用机理的研究——以万科股份有限公司为例

本文通过模型分析了可转换债券在公司连续融资中的作用机理;并结合万科公司利用可转换债券融资的案例,分析了万科转债在万科公司连续融资中发挥的作用。在万科公司以未来投资期权价值不确定为基础的连续融资过程中,当投资期权项目被证实有价值时,通过可转换债券的赎回(强制转换)把初始项目积累的资金转向有价值的投资期权项目,有利于万科公司有价值投资期权项目的后续融资,验证了Mayers(1998)的连续融资假说。     

RATIONAL TIMING OF CALLS OF CONVERTIBLE PREFERRED STOCKS

Conversion-forcing calls of convertible preferred stocks are re-examined focusing on the value of the conversion option impounded in the preferred price. This amount represents the preferred shareholder wealth potentially transferable to common stockholders. Capture of this wealth underlies the theoretical motivation for calling and forcing conversion as soon as possible. Most of the preferred issues examined exhibit nonpositive average option values throughout all but short periods; hence, no wealth transfer opportunity exists for immediate calls. Issues that exhibit positive option values are called quickly. In contrast to interpretations that have persisted for over fifteen years, our results reveal no substantial delays in calling convertible preferred stocks.     

Risk dynamics surrounding the issuance of convertible bonds

This paper analyzes the risk dynamics surrounding convertible bond offerings (CBOs) and Seasoned Equity Offerings (SEOs). As convertible bonds are commonly believed to be very effective at mitigating adverse selection or overinvestment problems we would expect differing risk and return patterns for convertible bond and seasoned equity issuers. By analyzing 1148 convertible bond offerings and comparing them to 2905 seasoned equity offerings, we show however that for both issuer types the systematic risk increases prior to issuance and drops sharply thereafter. This result is consistent with the notion of exercising real options, as growth options are always riskier than the underlying assets and exercising them at issuance causes an immediate drop in risk. The real option framework and the proposed dynamics of systematic risk also provide a rational explanation for the negative announcement effect, as well as any long-term underperformance subsequent to the CBO and the SEOs.     

Mixing and matching: Prospective financial sector mergers and market valuation

Which types of mergers are likely to be most productive for banks and other financial firms in the US? From a management perspective, mixing disparate firms may be difficult, but may offer significant gains from diversification. The opposite applies to matching similar firms. This paper considers life insurance, property and casualty insurance, securities, and commercial firms as potential matches for banks. It examines a measure of diversification gains from potential consolidation, based on option pricing, and a model of the “building blocks” of the industries, based on arbitrage pricing theory. The results identify potential diversification gains from virtually all combinations involving banking and insurance, which arise because common factors are combined in different ways and because insurance is already well diversified.     

Revisiting the merger and acquisition performance of European banks

The study examines the value creation of Merger and Acquisition (M&A) deals in European banking from 1990 to 2004. This is performed, first, by examining the stock price reaction of banks to the announcement of M&A deals and, second, by analysing the determinants of this reaction. The findings provide evidence of value creation in European banks as the shareholders of the targets have benefited from positive and (statistically) significant abnormal returns while those of the acquirers earn small negative but non-significant abnormal returns. In the case of the shareholders of the acquirers, domestic M&As and especially those between banks with shares listed on the stock market, seem to be more beneficial compared to cross-border ones or those when the target is unlisted. Shareholders of the targets earn in all cases positive abnormal returns. Finally, although the link between abnormal returns and fundamental characteristics of the banks is rather weak, it appears that the acquisition of smaller, less efficient banks generating more diversified income is more value creating, while acquisition of less efficient, liquid and characterised by higher credit risk banks is not a value creating option.