The relationship of G-Index and convertible debt issuance in the presence of restrictive covenants

We examine the relationship between the Governance Index (G-Index) and convertible bond use by firms, specifically in the presence or absence of covenants. We find that the better the share-holder governance (lower G-Index) of firms, the more they are likely to issue convertible instead of straight bonds. More importantly, we find that the complementary relationship between share-holder governance and convertible bond use is driven by the existence of certain covenants attached to these convertible securities. We also find that this effect is accentuated in firms with smaller size, higher market-to-book, R&D and intangibles as well as higher beta. We conclude that this link between strong shareholder rights and increased convertible bond use is conditional on the presence of covenants and therefore shows the important interaction of these three governance mechanisms. In addition, this triple link being emphasized in firms with higher agency costs and adverse selection problems is consistent with value-maximizing use of convertible bonds.