Convertible Bonds as "Back Door" Equity Financing

This paper argues that corporations may use convertible bonds as an indirect (albeit possibly risky) method for getting equity into their capital structures in situations where adverse selection problems make a conventional stock issue unattractive. Unlike other theories of convertible bond issuance, the model of this paper highlights: 1) the importance of call provisions on convertibles; and 2) the significance of costs of financial distress to the Information content of a convertible issue.