Where Are They Now? An Analysis of the Life Cycle of Convertible Bonds

AuthorTimo Korkeamaki,Timothy B. Michael
Date01 August 2013
DOIhttp://doi.org/10.1111/fire.12012
Published date01 August 2013
The Financial Review 48 (2013) 489–509
Where Are They Now? An Analysis of the
Life Cycle of Convertible Bonds
Timo Korkeamaki
Hanken School of Economics, Bank of Finland
Timothy B. Michael
University of Houston - Clear Lake
Abstract
We study the determinants of the life convertible bonds’ life span issued between 1980
and 1998. About 60% of the bonds survive either to a call or to their maturity. The issuers of
the remaining bonds are delisted during the life of their bonds. Calls and delistings shorten the
average life span of convertibles from the original 17 years to an effective life span of only
seven years. Issuer’s post-issuance performance and investment behavior affect the effective
life of convertibles. Our results support the sequential financing hypothesis, as bonds issued
by firms with speedier investment schedules have shorter life spans.
Keywords: convertible bonds, callability
JEL Classifications: G13, G30, G32
1. Introduction
Two points in the life cycle of convertible bonds have received lively research
interest, namely their birth in issuance, and their “death” through a call. However,
Correspondingauthor: Hanken School of Economics, Bank of Finland, P.O. Box 479, FI-00101 Helsinki,
Finland; Phone: (358) 40 3521 308, Fax: (358) 9 431 33 393; E-mail: timo.korkeamaki@hanken.fi.
C2013, The Eastern Finance Association 489
490 T. Korkeamakiand T. B. Michael/The Financial Review 48 (2013) 489–509
besides recent studies by King and Mauer (2012), and Grundy and Verwijmeren
(2012), few papers consider the entire life cycle of convertible bonds and the joint
determinants of their tenure. We aim to fill that gap with this study. We track the life
of a convertible bond sample that was initially issued between 1980 and 1998, and
study determinants of the effective life of those bonds.
Our study has two main goals. First, we seek to provide information concerning
factors that affect the end of life for these bonds. How common is it for them to be
called versus how many of them mature as bonds? How many of them cease to exist
for other reasons, such as mergers and firm failures? Second, we observe certain
design features in convertible bonds, and relate those design features to existing
literature that motivates their usage. Features such as conversion premium, coupon
rate, maturity,callability and call protection all come with potential costs and benefits.
We seek to evaluate how the use of these design features is related to the subsequent
behavior of the issuing firms. The existing studies on call policy of convertiblebonds
focus on factors such as yield differential and conversion premium as determinants
of call policy. Our focus is different, as we measure the calendar time that the bonds
remain active beyond their call protection period. Our results should be of interest
to convertible bond investors such as commercial banks, whose ability to remain
invested in the issue is limited after a forced conversionto equity, and to hedge funds
holding a convertible bond as one leg in a convertible arbitrage portfolio. For both
groups, an unexpected shortening of the life of a convertible bond would present
unexpected transaction costs.
Our results indicate that many convertible bond issuers are delisted during the
life of the convertible. Out of our 955 sample bonds, only 60% remain activeto either
a call announcement or to original maturity. Over 65% of the delistings, counting
for about 26% of the original sample, occur due to mergers, while about 12% of
the original sample is either liquidated or dropped by the stock exchange. Both
calls and delistings have the effect of significantly shortening the effective life span
of convertible bonds. For the overall sample, the effective life span falls from an
original time to maturity of about 17 years to a realized life span of about seven
years. In observing the connection between the design of convertible bonds and their
eventual life cycle, we exclude bonds whose issuers are delisted, as we assume that
mergers and bankruptcies are not foreseen at the time of the issuance.
We find that features in the original bond design have a limited effect on the
length of the bond’s life. Bonds with longer original maturities survive longer as
bonds, and bonds with higher (original) yield advantage tend to be called sooner.
Call protection type and conversion premium fail to affect the bonds’ life cycle in
a consistent manner. Issuer’s performance after issuance, however, has a significant
effect on the life span of the convertible. Higher post-issuance stock returns shorten
the life of convertibles, and improvements in an issuer’s credit rating have a similar
effect.
Most interestingly, firms with high capital expenditures subsequent to issuance
call their bonds sooner. That finding is consistent with the sequential financing

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