What we do and do not know about convertible bond financing

We review the literature on the issuance motives, shareholder wealth effects, and design of convertible bonds. Empirical studies on convertible debt issuance mainly focus on testing the predictions of four traditional theoretical models based on convertibles' potential to mitigate agency or adverse selection costs, and obtain mixed evidence. Recent studies on shareholder wealth effects of convertible bond issues highlight the need to control for arbitrage-related short selling and post-issuance risk changes. Studies on the determinants of convertible bond design uncover earnings management, as well as catering incentives to convertible arbitrage funds, as important determinants of innovations in convertible bond characteristics. Overall, our review indicates that recent empirical research on convertible debt provides valuable insights into issue motives and determinants of financial innovations, but also considers the broader question of how investor demand characteristics impact corporate finance decisions. We conclude with an overview of potential research questions to be addressed by future research on hybrid securities.

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