The staged financing hypothesis of Mayers [Mayers, D., 1998. Why firms issue convertible bonds: The matching of financial and real investment options. Journal of Financial Economics 47, 83–102] predicts that investment and financing activity will increase following in the money convertible bond calls. The prediction for out of the money convertible calls is different: no increase is expected. We study the rate of both corporate investment and external financing around forced conversions using benchmarks that are analogous to those recommended by Barber and Lyon [Barber, B., Lyon, J., 1996. Detecting abnormal operating performance: The empirical power and specification of test statistics. Journal of Financial Economics 41, 359–400]. We also examine the cross-section of changes in investment and financing activity. Conversion-forcing firms exhibit an increase in both capital expenditures and debt financing around the year of the convertible bond call; however, the same result holds for the sample firms that conducted out-of-the-money convertible calls. Further, there is no relation between changes in investment activity and changes in debt issuance at the firm level. The evidence is inconsistent with the notion that forced conversions serve as a catalyst for staged financing and investment.

Bonds with either fixed price or make whole call provisions allow for the efficient recontracting of claims, but they differ in terms of their ability to mitigate debt agency costs. Controlling for the influence of bondholder-shareholder conflicts on both the level of covenant protection and selection of a particular type of call provision, we show that firms select call provisions with greater sensitivity to changes in the option-free value of the bond when agency problems are more severe. Our findings are consistent with the Barnea, Haugen and Senbet (1980) theorem that firms select fixed price callable debt to mitigate bondholder-shareholder conflicts.

Numerous studies have examined the impact of security issuance upon the value of pre-existing debt and equity but the focus has largely been on changes in equity value. We examine changes in senior unsecured debt risk premiums that accompany new junior debt issues. Additionally, we test several hypotheses regarding the potential impacts of junior debt issues. Extant theory suggests senior debt value may be threatened under certain conditions by the issuance of junior debt. Our results indicate that when junior debt replaces bank debt, senior default risk premiums experience abnormal declines. The result is broadly consistent with the elevation of the senior unsecured debt by way of the elimination of a separate and more senior class of debt claimants. In contrast, we also find that larger junior bond issues are associated with abnormal increases in senior risk premiums, broadly consistent with issue size being correlated with negative information about firm cash flows. We find strong evidence of interaction effects. For example, replacement of bank debt results in greater changes in default risk premiums the larger the issue size. We also find lower credit ratings magnify other effects. For example, if the junior debt issued matures before the outstanding senior unsecured bond, senior risk premiums experience abnormal increases for lower rated debt.

There are three important dimensions of liquidity: trading costs, depth, and resiliency. We investigate the relevance of each of these three dimensions of liquidity – separately and in conjunction – for the pricing of corporate bonds. Unlike previous studies, our sample allows us to cleanly separate the default and non-default components of yield spreads. We find that each of the above three dimensions of liquidity are priced factors. Overall, in our sample, a one standard deviation change in trading costs, resiliency, and depth measures lead to a change in non-default spreads of 5.00 basis points, 2.27 basis points, and 1.27 basis points, respectively. We also find that both bond-specific and market-wide dimensions of liquidity are priced in non-default spreads. Finally, we find that there does exist in some periods a small residual non-default yield spread that is consistent with an additional “flight-to-extreme-liquidity” premium reflecting investor preference for assets that enable quickest possible disengagement from the market when necessary.