Enrique Arzac

Percs, Decs, and Other Mandatory Convertibles

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Abstract:
In this article I begin by discussing the rationale for mandatory convertibles from the point of view of issuers as well as investors. In general, convertibles securities reduce the costs of "information asymmetry" that can make equity offerings especially expensive for some smaller, high-growth companies (or any firm with little additional debt capacity where management is convinced its shares are undervalued). Mandatory convertibles play a similar role for larger, often highly leverage or financially troubles, companies that are seeking equity capital, but want to avoid unnecessary dilution. Much as convertibles accomplish for smaller growth firms, mandatory convertibles enable large issuers with growth (or recovery) prospects that may not be fully reflected in their current stock prices to "signal" their confidence. (In designing "synthetic" convertibles, buy contrast, investment bankers are choosing larger growth companies like Microsoft and Amgen that tend to avoid issuing securities with appreciable interest or dividend requirements.)

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