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Our third hypothesis is that the market's reaction to an announcement of a convertible bond offer varies with whether the firm truthfully reveals firm quality at the offer announcement.
3a]: The average wealth change following announcements of convertible bond issues that are subsequently converted into equity is significantly lower than that of issues that are not subsequently converted into equity.
We first identify all calls and redemptions of convertible bond issues between January 1968 and December 1988.
A convertible bond is characterized as being out-of-the-money if the conversion value is below the effective call price on at least one of the two days around either event.
This scenario tells us nothing about whether the original convertible bond could or would have been in the money if the firm had not called the issue for refunding purposes.
For each convertible bond remaining in our sample, we trace the debt issue back to the original issue date.
For mimicking to be effective, the convertible bond contract terms set by mimickers should be similar to those of other issuers.
If firms that subsequently call or redeem their convertible bonds out-of-the-money are lower-quality issuers mimicking higher-quality firms, they should, on average, be riskier than convertible bond issuers that obtain back-door equity financing.
One behavioral implication of these studies for our sample is that convertible bond offer announcements should follow information releasing events.
Since the results thus far are consistent with our hypothesis that some firms are mimickers, we now examine whether the market's reaction to a convertible bond offer announcement varies with whether or not the firm mimics higher-quality firms at offer announcement.
We determine the market model parameters by using daily returns on the CRSP tapes over a 150-day period that begins 350 days and ends 201 days prior to the announcement of the convertible bond issue.
Issuers of more traditional instruments like convertible bonds and employee stock options could be affected as well.