TY  - JOUR
AU  - Jaffee,Dwight
AU  - Shleifer,Andrei
TI  - Costs Of Financial Distress, Delayed Calls Of Convertible Bonds, And The Role Of Investment Banks
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 2558
PY  - 1988
Y2  - April 1988
UR  - http://www.nber.org/papers/w2558
L1  - http://www.nber.org/papers/w2558.pdf
N1  - Author contact info:
Dwight Jaffee
Haas School of Business
University of California
Berkeley, CA  94720-1900
Tel: 510/642-1273
Fax: 510/643-7441
E-Mail: jaffee@haas.berkeley.edu

Andrei Shleifer
Department of Economics
Harvard University
Littauer Center M-9
Cambridge, MA 02138
Tel: 617/495-5046
Fax: 617/496-1708
E-Mail: ashleifer@harvard.edu
AB  - In a frictionless market with perfect information, a shareholder-wealth- maximizing firm should force conversion of its convertible bond issue into stock as soon as the bond comes in-the-money. Firms however appear to systematically delay forced conversion, sometimes for years, beyond this time. We show that the observed delays can be plausibly explained in terms of costs to shareholders of a failed conversion and the ensuing financial distress. Firms delay the forced conversion to avoid the self-fulfilling outcome that bondholders expect the conversion to fail, tender their bonds for cash, and the stock price falls to account for the costs of financial distress, in which case tendering for cash is in fact optimal. Unlike other explanations of delayed forced conversion, we can explain the common use of investment banks to underwrite these transactions, since the banks can eliminate the self-fulfilling bad outcome.
ER  -