Market Impact Of Convertible Bond Issues In China

Convertible bonds are hybrid securities with characteristics of both equity and debt. Convertible bondholders have the options to convert the bonds to equity at a specified price during a given period. And before doing so, convertible bondholders are entitled to receive coupons, and receive principal if they don’t exercise the option. Several advantages have been cited for increased convertible financing. Practitioners propose notions such as delayed equity, lower interest costs relative to the straight bonds as the "sweetening" of deals. Brennan and Kraus (1987, p.1225-1243) and Brennan and Schwartz (1998, p.55-64) argue that convertible bonds are ideal for firms suffering from the information asymmetry problem, since the hybrid nature of the securities makes the mispricing of the debt component to be offset by the mispricing of the equity component. Convertible bonds can also alleviate the conflict between stockholders and bondholders with regard to the risk shifting and wealth appropriation problems by allowing convertible bondholders to participate in potential growth (Mehta and Khan,1995, p.782). For investors, they may also find convertible bonds attractive because they provide protection as a bond with combination of some upside potential of a stock. However, risks remain in the rise of the company’s leverage, probability of default, and a potential dilution of the company’s stocks for stockholders.This research focuses on the Chinese convertible bonds market. I have examined the market impact around the announcement date of convertible bonds issues by the Chinese listed firms. This is achieved by conducting event studies on the firms’ stocks traded in the Shanghai Stock Exchange and Shenzhen Stock Exchange, and I have focused on the convertible bond issues during the period from 2005 to 2009. According to the descriptive analysis of the samples, the convertible bonds issuers during this period have a rather large asset base and market capitalization. They have low leverage in their capital structure and they are the companies that are well-known to domestic investors. Standard event study methodology is employed to estimate the market impact brought by convertible bond issues announcements. Singe-factor market model is employed to esl imate the beta coefficient for each stock, and the expected returns for each day during the (-30,30) period are estimated. Abnormal returns are calculated as the result of the actual return minus the expected return. Cumulative abnormal returns are subsequently arrived by summing up the abnormal returns for different event windows. The results showed significant positive cumulative average abnormal returns of 3.69% for the event window (-1,0) and a significant 3.4% for the (-1,1) event window. And the average cumulative abnormal return for the event window (-30,0) and event window (0,1) is 8.92% and 1.95% respectively, both of which are significant. Afterwards, the cumulative abnormal return for window (2,10) turns negative at-2.13%, which is significant at the 10% level. Most of the convertible bond issues are perceived positively by the market. It seems that the current shareholders are quite pleased with the issues of convertibles as a means of financing, and they do not worry about the potential dilution to their ownership if conversion occurs in the future. These results are in contrast with the relevant researches in the US and UK market, and some of the European markets.I have also examined the determinants that can explain the positive cumulative abnormal returns from convertible issues in China. The factors tested are company size (total assets), convertible bond design (delta), leverage (long-term liabilities over total assets), growth (Tobin’s Q ratio), agency cost (sales, general and administrative expenses over net sales) and financing cost (10-year Treasury bond yield deflated by inflation). Among these factors, leverage, growth, agency cost and financing cost have positive impact on the cumulative abnormal returns, but only agency cost has significant explanatory power for all the event windows tested, which are the (-30,0), (-2,0), (-1,0) and (-1,1) event windows. Leverage also has significant explanatory power for the cumulative abnormal returns in the event window (-30,0). These results show that the market considers the convertible bonds issues as good news for those firms with relatively severe agency problems, because the debt feature of convertible bonds helps alleviate the agency problem between shareholders and managers, and convertible bonds provide incentives for managers to maintain liquidi ty for debt service and future growl h project s Financing cost, when taken alone, has significant explanatory power for the positive cumulative abnormal returns. But when other variables are controlled, financing cost ceases to explain much of the variations in the cumulative abnormal returns. This indicates high financing cost may be an important motivation for convertible bond issuance (since convertible bonds can effectively reduce coupon rates compared to straight bond), but it is not the characteristic the market is looking for in a convertible bond issue. The positive coefficients for growth and leverage may indicate the market perceives convertible bonds issued by firms with higher growth attractive, but the coefficients are not significant enough to draw such a conclusion. The company size doesn’t seem to be able to explain the positive market impact, and this may be due to the fact that the majority of the firms permitted to issue convertible bonds in China are those with larger size and stronger operations. They receive a lot of analyst coverage and suffer less from information asymmetry, and therefore convertible bonds just don’t serve as a tool to improve information asymmetry problem.1 also examine the long-term stock performance of the convertible bonds issuers. Abnormal returns are summed up from the announcement day up to one month, three months, six months and one year after the announcements. The samples do not demonstrate a consistent pattern for long-term stock performance. Some of them have very positive cumulative abnormal returns, and some others demonstrate the opposite results. When put together and averaged across all samples, the positive and negative numbers offset each other, therefore the variations in stock price performance are very huge among the samples. And the standard deviations increase as the event window grows longer. This result is in contrast with some of the researches in the US market, in which long-term performance of convertible bonds issuers demonstrates negative cumulative returns up to one to three years.The uniqueness of the Chinese capital market may explain the differences in market impact of convertible bonds issues. Compared to its American and European counterparts, the Chinese capital market is largely a closed market to the world, offers limitde investment vehicles prohibits the existence of hedge funds, and undertakes the "approval" approach to securities offering.