Equity-like mandatory convertibles: a capital raising alternative

Abstract

Hybrid securities has played an important role in helping firms with their specific business strategy challenges by mitigating market imperfections and increasing sources of capital and costs efficiency through the deep customization they generally allow. In this work, I study equity-like mandatory convertible securities, its issuers’ characteristics, needs and challenges. These securities are dividend enhanced, automatically converted into common equity at maturity and have either limited or capped upside potential while fully participating in the downside losses. I find that firms issuing mandatory convertibles have greater non-debt tax shields and lower corporate tax rates, suggesting a tax exhaustion state. Issuers also display higher default probability, lower levels of internal funds, liquidity, solvency and financial stability and, more importantly, a deterioration of these variables close to the offering, which supports the choice for a safer option to raise capital whenever firms are financially troubled, highly levered and/or generally incapable of complying with future debt commitments. Despite some industry biasedness, some evidence shows that managers support their decisions on industry target benchmarks (e.g. indebtedness levels) and that equity-like mandatory convertible securities help firms with sequential financing needs.