with Martin Junker Nielsen

Abstract

Within the context of the Leland (1994, 1998) capital structure model, this paper examines the pricing and optimal exercise strategy of convertible debt. In the absence of bankruptcy, we derive analytical solutions when convertible debt is held by either several competitive debtholders or by one monopolist. The results show that, in the presence of corporate taxes, both the competitive debtholders and the monopolist will exercise sequentially. The paper examines the effect of introducing bankruptcy, and shows that default risk may, in some cases, increase the value of convertible debt. We also explain why firms might issue convertible debt by proving that if the firm can restructure its debt after conversion, then convertible debt increases the value of the firm

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