Tax Shields, Sample-Selection Bias, and the Information Content of Conversion-Forcing Bond Calls

Abstract

ABSTRACT The information content of conversion‐forcing bond calls depends on the after‐tax cash flow to bondholders. If the dividend after conversion exceeds the after‐tax coupon but is less than the before‐tax coupon, the call reveals unanticipated decreases in dividends and/or earnings that reduce the tax shield from interest payments. In contrast, a call when the dividend is less than the after‐tax coupon reveals the timing of an anticipated shift from exceptional firm‐specific positive growth to the industry norm. Efforts to document properties of convertible calls are subject to sample‐selection bias because calls are disproportionately associated with positive pre‐call firm‐specific growth.

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