The impact of convertible debt financing on investment timing

We develop a model to examine the timing of investment decisions in relation to the issuance of convertible debt by firms. Our model shows that when the demand shock has higher volatility, the firm finances the investment cost with high-coupon convertible debt. We find that default occurs earlier for firms that finance with convertible debt rather than with straight debt. We also find that firms with high-growth prospection, high volatility, and low capital costs that issue convertible debt tend to defer investments. Furthermore, we examine the investment decisions in which the convertible debt includes a call provision. We show that firms that use callable convertible debt invest earlier than those that use non-callable convertible debt by using suboptimal coupon payments. The opportunity from the forced conversion increases as the volatility increases. These results are consistent with recent empirical evidence. ► We examine the optimal strategy for the investment financed with convertible debt. ► The firm of higher volatility finances with high-coupon convertible debt. ► The magnitude of optimal coupon payment has large impact on investment strategies. ► The firm financing with callable convertible debt invests relatively early. ► The opportunity of forcing-conversion increases as the volatility becomes large.