The Long-Run Operating Performance of Canadian Convertible Debt Issuers: Trends and Explanatory Factors

ABSTRACTSimilar to previously documented evidence for offerings, this paper shows, using accounting-based performance measures, that Canadian firms exhibit a poor operating performance following convertible bond offers. These results confirm those obtained in the US context and contribute to explain the puzzling post-issue stock price underperformance of convertible bond issuers. Our findings also illustrate that the decline in operating performance experienced by the issuing firms seems to be partly due to industry specific factors. In addition, using PLS regressions, we find that some issuer and issue features have a significant impact on the issuers' performance. Nevertheless, the signs of the regression coefficients are not always congruent with those predicted by convertible bond financing theories. Lastly, our empirical findings support the capital rationing hypothesis of Lewis et al. (2001) according to which firms rely on convertible bonds because they are rationed out of the market due to adverse selection and agency costs considerations.JEL Classifications: G14, G32Keywords: convertible bonds offering; long-run operating performance; PLS regressionsI. INTRODUCTIONConvertible bonds (hereafter referred to as CBs) have been used extensively by corporations to raise funds in the bond market through either public or private offerings. According to the agency and signalling theories, in an imperfect market CB financing is not without incidence on the value of the issuing firm. This report confirms the results of previous empirical studies carried out over various periods and in several countries.1 Indeed, the main conclusion of these formally termed event studies, is that the announcement of CB offering is associated with a negative signal, but with it, the impact is less pronounced than with the announcement of issuance. Given that straight bond offerings do not involve on average any statistically significant reaction, this result seems coherent with both the pecking order theory of Myers and Majluf (1984) and the backdoor equity model of Stein (1992).2These studies have investigated stock market reaction to the CB issuance during short-term announcement period assuming that markets are efficient at least under the semi-strong form. However, more recent literature on the long-term behavior of firms' stock price subsequent to Initial Public Offerings (IPOs) and Seasoned Equity Offerings (SEOs) challenged this assumption. It argued instead that the return decrease taking place at the time of the issue announcement was not proportional to the actual informational content of the news at that moment. Indeed, stock issuers' returns continue to decline during several months after the offering. In other words, investors would interpret in an erroneous way the signal conveyed by the issuing firm at the offering announcement period, with the result being that they would take a long time to appraise its real effects on the value of the firm. This underreaction calls into question the principle of informational efficiency.In light of these studies and since CBs are hybrid instruments with characteristics of both debt and equity, many authors turned towards long-term event studies in order to examine CB issuers' post-offering returns over long horizons to get a full view of their stock price performance. Lee and Loughran (1998) and Spiess and Affleck-Graves (1999), amongst other authors, find that American firms issuing CBs significantly underperform their matched counterparts up to five years after the offering. Similar underperformance was found on both the Japanese (Kang et al., 1999) and the British markets (Abhyankar and Ho, 2006). One key element of these studies is that the long-term driftin stock returns is in the same direction as the initial reaction of the stock price at the time of the announcement. This suggests that, as with offerings, investors tend to underreact to the information contained in the announcement, so that the full impact of the CB issue is only recognized over a longer time horizonBecause the primary role of accounting information, more precisely accounting earnings, is to provide useful input to analysts and investors in financial markets, some authors have examined to which extent the decline of firms' long-term stock price profitability subsequent to CB offerings is driven by the fall of their operating performance. …

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