Convertible Subordinated Debt Financing and Optimal Investment Timing

Abstract

In this paper, we examine the optimal investment policy of the firm which is financed by issuing equity, straight debt and convertible debt with the senior-sub structure. The senior-sub structure gives preference to straight debt over convertible debt and to convertible debt over equity when the default occurs. We investigate how the senior-sub structure affects the optimal policies for default, conversion and investment the values of equity, straight debt, convertible debt and investment. In particular, we show that the senior-sub structure for the equity, the straight debt and the convertible debt leads to the accelerating conversion, decreases the values of convertible debt and investment, and does not really affect the default and the investment.