Optimal Debt Service: Straight vs. Convertible Debt
نویسنده
چکیده
In this paper, we analyze the optimal default strategy of a firm when debt is convertible into equity. For this purpose, we consider a convertible consol bond in a time-independent model in the presence of bankruptcy costs and tax deductability. The optimal default and conversion strategy result from a game between equity and debt holders. We show that an optimal default of convertible debt occurs earlier than a default of otherwise identical straight debt. Although the value of convertible debt is lower when the firm follows the optimal debt strategy rather than the strategy for straight debt, the values of the investment and option component of the convertible debt can be higher. Furthermore, we find that the important difference between the default barrier for convertible and identical but non-convertible debt rises with the conversion ratio, the promised coupon, a lower tax rate, and a lower payoff rate. JEL Classification: G12, G32
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