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PRELIMINARY AND INCOMPLETE

By Pierre Hillion and Theo Vermaelen

Abstract

helpful comments and Gene Fama for providing monthly factor returns. This paper was completed when the second author was visiting scholar at UCLA. Death spiral convertibles are privately held convertible securities (preferred stock or debentures) with a conversion price that is set at a discount from the average (or sometimes the minimum) of past stock prices in a look-back period. These securities have been called “death spirals ” because of their potential to create dilution and stock price declines. On the basis of a sample of 487 issues between 1995 and 1998, we find that this bad reputation is indeed justified: an investor who buys the common stock of the issuer loses, on average, 34 % of his wealth one year after the issue date. This is not due to outliers: 85 % of the issuing firms experience negative returns in the year after the issue. This result is remarkable considering that our sample coincides with one of the strongest bull markets in US history. We also document in detail the different contract characteristics and test whether contract design has an impact on long-term performance. The most important predictor of poor longterm performance is the discount.

Year: 2000
OAI identifier: oai:CiteSeerX.psu:10.1.1.195.260
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