Abstract

It is not uncommon for convertible bonds to have a conversion-price reset option built in, especially in Taiwan. Downward resetting of conversion price raises the conversion ratio and hence induces heavier potential dilution on EPS upon conversion. On the other hand, downward resetting of CP also enhances the likelihood of conversion and therefore ease the cash flow burden of principal repayment. While the former, called dilution effect, is predicted to be negative, the latter, called debt alleviation effect, is predicted to be positive- on the underlying share price. It is found in this paper, using Taiwanese data, that share prices do not react in any significant way around the announcement date of CP downward resetting. Share prices however do react negatively around the effective date of the resetting event, making dilution effect dominant over debt alleviation effect. After reviewing the operating performance between the CB issuing period and the CP resetting period, we find that sales growth, return on assets and operating cash flow have all been worsening off, which may explain the motivation behind the decision of CP downward resetting.
Intuitively, the higher the magnitude of CP downward resetting, the more the dilution effect will be. But for companies suffering from severe cash flow shortage, the opposite effect may prevail. In other words, when CP reset by close to 20% downward (the legal limit), share prices react positively to the event, i.e., debt alleviation effect becomes dominant.