EXPLORING OPTIMAL CALL POLICIES FOR CONVERTIBLE BONDS: THE TRADE-OFF BETWEEN WEALTH TRANSFERS AND SIGNALING EFFECTS

Abstract

The current study compares the best call policies of convertible bonds in Pakistani capital market with respect to the trade-off between wealth transfer and signaling. This research analyzed 85 convertible bond issues of Pakistani Stock Exchange-traded companies during the period of 2020-2024 based on a mixed-methods research design. The methodology adopted in the evaluation of the abnormal stock returns and the impact on bondholder wealth of 21 days preceding the announcement of the call is event study. The multiple regression analysis identifies the determinants of the optimal call timing and the effects of these determinants on the wealth of the stakeholders. The key variables include cumulative abnormal returns, conversion premium, measures of call timing, stock volatility and firm-specific signaling variables. The analysis controls interest rate settings, stock prices, the size of the firm, leverage ratios, and the market to book ratios. The results suggest that firms are faced with a complex optimization problem since timely call maximizes the wealth transfer to shareholders and broadcasts bad news, and timely and delayed calls respectively guard credibility and reduce wealth. The paper finds that on conversion of convertible notes, Pakistan firms tend to offer conversion premiums of 18-22 on the notes and this shows that both the issue of wealth redistribution and information asymmetry are solved in a moderate way. Statistical analysis using STATA and EViews will demonstrate that the most effective call policies will depend on the market structure, the characteristics of firms and the relative importance of the signaling and wealth transfer motives.