Death spiral issues in emerging market: A control related perspective

This paper studies the motive of issuing floating-priced convertibles or warrants, known as death spirals, in a country where private benefit of control is high. Using a total of 199 death spiral issuances by public firms listed in the Korea Stock Exchange during 1998–2006, we find a number of pieces of empirical evidence that are less consistent with the conventional last resort financing hypothesis, but rather consistent with the control enhancing or control transferring hypothesis. First, abnormal returns subsequent to death spiral issuance is negative, but more so in poorly governed firms. Second, operating performance of chaebol issuers are not necessarily low at the time of the issue nor does it deteriorate over time, but they still prefer to issue death spirals over traditional fixed-priced hybrid securities. Third, we do not observe subsequent changes in the controlling shareholder in more than 60% of the issuers and these firms exhibit superior operating performance at the time of the issue compared to other death spiral or non-death spiral issuers. Fourth, proportional ownership of the controlling party in these firms does not decrease, while the number of shares held by family members other than the controlling shareholder increases. Finally, in approximately half of these firms, at least one member of the controlling party holds hybrid securities that can later be converted into voting shares.

► Death spirals — floating priced CBs or BWs — may be used to enhance control rights.
► Unlike in US, death spiral issuers in Korea are not necessarily poor performers.
► Chaebols issue death spirals although they perform better than non-chaebols.
► Number of shares held by other family members increase after a death spiral issue.