Why Do Companies Issue Mandatory Convertibles?

By Anja Cavigilli, Institut für schweizerisches Bankwesen der Universität Zürich , 16 August 2005

Mandatory convertible securities (MCS) have been widely used in the USA for quite some time, but only in recent years have they started to become more well-known in Europe. And now a growing number of companies in the Swiss market are discovering this new form of financing. This increasing popularity raises a few questions. What reasons do companies have for issuing this complex financial instrument? And is there sufficiently large market demand for this instrument?

Executive Summary

Objectives

This thesis investigates the reasons for issuing mandatory convertible securities (MCS). It begins by examining MCS and how they function as well as by comparing MCS to convertibles, a related type of security. An assessment of MCS entails evaluating their legal, tax and economic aspects with respect to the individual parties involved. When the thesis looks at the reasons for issuing MCS, it focuses particularly on the incentives of the issuer. Since information asymmetry and financial distress costs are significant topics concerning issuing motives, these two phenomena receive special emphasis. From the standpoint of investors, MCS offer no capital protection. This therefore raises the question of whether the desired investment features and the personal risk profile are sufficiently taken into account when an investor buys such a financial instrument.

The thesis additionally examines the announcement effect that an MCS issue has on the stock price of the issuing company. And at the same time, it also looks at the long-term performance of an MCS issuer. Based on the history of MCS and convertibles, the thesis aims to illuminate differences between the USA and Europe. It concludes by evaluating the potential of MCS for the European and especially the Swiss financial market.

The thesis deliberately avoids considering so-called exchangeables. This is because other issuing motives play a role for these convertibles, which are exchanged into the common stock of a company other than the issuer.