Creditor Right Protection and Convertible Bonds Strategic Issuance: Evidence from the Establishment of China's Specialized Bankruptcy Courts
XIE Weimin, GUO Jialu, ZHANG Hengxin
School of Accounting, Dongbei University of Finance and Economics; School of Public Finance & Taxation/School of Accountancy, Shandong University of Finance and Economics
Summary:
In recent years, convertible bonds have become a significant refinancing channel for Chinese listed firms, with their market prominence increasingly highlighted. Compared to traditional bonds and equities, convertible bonds offer greater flexibility in contractual terms, and their complex clauses shape the dynamic balance between their debt and equity features. Specifically, the debt-like nature of convertible bonds is manifested in the bondholders' claim to the face value and fixed interest payments before conversion, while their equity-like nature is reflected in holders' rights to share in the residual value after conversion. However, firms may issue convertible bonds not merely for financing purposes but also to exploit speculative opportunities that promise short-term gains. As an emerging market, China exhibits relatively weaker protection for creditors. The development of bankruptcy legal frameworks, a direct reflection of creditor protection, focuses on building a robust legal system and an efficient judiciary to effectively safeguard creditors' legitimate rights and interests during firm liquidation. Nevertheless, the impact of bankruptcy legal framework development on convertible bond issuance and its underlying motivations remains unexplored. Therefore, in the context of China's increasingly refined bankruptcy legal system, this study aims to investigate the impact of enhanced creditor protection mechanisms on firm convertible bond issuance behavior and its underlying mechanisms. Based on a quasi-natural experiment of the bankruptcy court establishment in Chinese prefecture-level cities, this study empirically examines the impact of creditor protection on convertible bond issuance from the perspective of bankruptcy legal system development. The findings reveal that after the establishment of bankruptcy courts, local firms are more likely to use convertible bonds for financing, and the equity-like nature of these bonds significantly increases. Furthermore, the mechanism tests show that the “backdoor equity” and “risk shifting” motivations are the primary channels through which bankruptcy courts affect the attributes of convertible bonds. The heterogeneity analysis shows that the establishment of bankruptcy courts has a more pronounced impact on promoting the issuance of equity-like convertible bonds in firms with weak internal governance, inadequate external monitoring, lower creditor protection levels, and in regions with relatively weaker financial regulation. Finally, further tests demonstrate that after the establishment of bankruptcy courts, issuing equity-like convertible bonds reduces investment efficiency, encourages firms to increase investments in speculative financial assets, and decreases funding for R&D projects, providing evidence for the strategic motivations behind convertible bond issuance. The marginal contributions of this study are threefold. First, in the context of the Chinese market, this study enriches the literature on the economic consequences of creditor protection. By analyzing the impact of bankruptcy courts on the strategic issuance of convertible bonds, it reveals how firms may circumvent legal constraints through the design of financial instruments following the strengthening of creditor protection. This finding not only supplements the discussion on the potential negative effects of creditor protection but also provides practical insights into the dynamic interplay between policy and firm strategies in emerging markets. Second, this study extends the literature on the microeconomic effects of bankruptcy court establishment. By leveraging the exogenous shock of bankruptcy court establishment, it reveals how the development of bankruptcy legal frameworks influences firm strategic choices in convertible bond issuance through the enhancement of creditor protection mechanisms. The findings provide a novel theoretical perspective on the role of bankruptcy courts in financial markets and offer valuable insights for improving bankruptcy legal systems. Third, this study deepens the understanding of the relationship between the legal environment and the contractual design of convertible bonds. It provides a theoretical foundation and policy recommendations for policymakers to refine the design of bankruptcy judicial systems, optimize financial instrument innovation, and promote high-quality development of the financial sector.
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