4 Signaling with Convertible Debt in the Renewable Energy Industry
Convertible debt is an important component of the range of financing options available to corporate managers. The setup of straight debt with an attached call option reduces the cost of debt when traded as a bond, while strengthening the equity capital base when converted into equity. Convertible debt can be a valua- ble financing tool when the risk level of the issuer is difficult to estimate. It can act as a hedge for investors, because changes in the value of the debt component are (at least partially) offset by value changes in the option (Brennan and Schwartz, 1988). Moreover, convertibles can be structured quite flexibly to match different cash flows and efficiently finance sequential investment projects (Mayers, 1998). As illustrated by their frequent use in the venture capital industry, such features make hybrid securities particularly attractive as a financing structure for high- risk companies (Kim, 1990; Schmidt, 2003; Trester, 1998).28 They can play an important risk-mitigating role in the development of new technologies in emerg- ing industries. However, due to the private nature of the venture capital industry, research on the structure, signaling effect, and valuation impact of convertible debt in such high-risk industries has thus far been limited. Despite the im- portance of these types of companies for economic development (Lerner, 2009), as well as academic and political debate over their funding (Cressy, 2002; OECD, 2006), most research has concentrated primarily on cross-industry stud- ies focused geographically on the U.S. In this chapter, we take a life-cycle and...
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