The signaling effects associated with convertible debt design

In this paper we investigate whether the terms used in the design of a convertible debt issue act as a signal of the issuing firm's future growth prospects. Our general premise is that convertible debt design terms are interrelated and arranged in a manner that signals asymmetric information to market participants. Empirical tests support our hypothesis, even after controlling for risk, firm size, time-to-maturity, and industry effects. Firms issuing convertible debt that arrange terms to take advantage of relatively better future growth prospects are found to have a relatively lower negative price reaction around the announcement of the offer.