Open Journal of Social Sciences, 2015, 3, 165-170
Published Online November 2015 in SciRes.
How to cite this paper: Pan, Y. (2015) Effect of the Issuance of Convertible Bonds on the Company’s Agency Costs. Open
Journal of Social Sciences, 3, 165-170.
Effect of the Issuance of Convertible Bonds
on the Company’s Agency Costs
Yu Pan
School of Economics, Jinan University, Guangzhou, China
Received 19 October 2015; accepted 14 November 2015; published 17 November 2015
Copyright © 2015 by author and Scientific Research Publishing Inc.
This work is licensed under the Creative Commons Attribution International License (CC BY).
The separation of ownership rights and management rights on shares of a Joint-stock company
leads to agency co nflicts between shareholders and managers. With the separation of owne rs hi p
and management of financing funds making the interests of shareholders contradict the interests
of its credit ors , the company’s ag e n cy costs come into being as a result. Through an empirical re-
search on agency costs of 79 non-financial listed companies who issued convertible bonds during
the ye ar 2002-2013 in China, whethe r the issuance of the convertible bond is beneficial to reduce
agency cost of listed companies is examined. The empirical results show that the issuance of con-
vertible bonds contri bu tes to the redu cti on of agency cost s, wh i ch supports the assumpti on con-
cluded from the theoretical r ese arches condu cted by foreign researchers that convertible bonds
can reduce agency c ost s in s ome ex tent.
Convertible Bonds, Agency Costs, Lis te d Companies
1. Introduction
As an innovative hybrid financing instrument, convertible bonds has relatively lower interest cost than bonds
and bears less risk than equity finance as well. Thus, it becomes a relatively favored way to refinance in the cur-
rent capital markets. While in fact, the convertible bond is not only just a financing tool which acts as both debt
and equity, but also a tool that can, to a certain extent, govern the company and can make the agent conflicts
between shareholders and creditors, and agent conflicts between shareholders and managers less acute. However,
judging from the current capital market situation, many domestic listed companies have ignored the role of con-
vertible bonds in improving corporate governance mechanism, but merely see it as a kind of refinancing tool
similar to additional issuance and allotment of refinancing. In fact, the convertible bonds not only have both
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functions of the creditor’s rights and the equity stake, but also contain an inbuilt action of options. So it is not
just a way to refinance. It can play a unique role in governance.
Due to the separation of ownership and management rights of enterpr is e s, the interest of managers and the in-
terest of owners (i.e. Shareholders) will often conflict, mainly shown as ineffective investment, namely unde-
rinvestment and overinvestment. Meanwhile, due to the ownership of the financing funds belongs to the credi-
tors, while shareholders have the right to use the money, so such separation state of ownership and management
will cause a conf lict between the interests of creditors and shareholders as well. In general, creditors are risk-
averse while shareholders are risk lovers. So there is contradiction in the ideas of using debt funds between the
two parties. Shareholders want to have more debt funds invested in risky but high-yielding projects, which is so-
called assets substitution behavior. Especially when companies are in financial difficulties, since the sharehold-
ersright to claims for the company’s liquidated assets is in the last, so they will invest in project with high risk
and high returns to give it a go, and this will exacerbate the asset substitution behavior. As the respective inter-
ests of the company on its principal-agent chain, the vital interests of shareholders, creditors and managers will
be under significant impact after the issuance of convertible bonds.
Western scholars’ theory studies of convertible bond financing illustrated that convertible bond could de-
crease agency cost and improve the performance of corporate governance (Mayers, 1998 [1]; Schmidt, 1999 [2];
Green, 1984 [3]; Stein, 1992 [6]). However, can convertible bond in China decrease the agency cost and im-
prove the performance of corporate governance as well as in the West? This paper tries to discuss the relation-
ship between convertible bond and agency cost, and then provides reference on reducing agency conflict inside
enterprises and improves the value of enterprises.
2. Literature Review and Commentary
Mayers (1998) [1] fully believed that convertib le bonds can eff e c tively reduce speculation and risk-taking beha-
vior of managers, reduce u nreasonab ly high investment risk due to the result of the equity financing by man-
agement. Convertible bonds can reduce the unreasonable high investment risk on the one hand while also re-
mind investors of capital investment risk, which makes it a better way of corporate finance. Schmidt (1999) [2]
built a model under the situation of Sequential investment and proved that convertible bonds can clearly moti-
vate managers to work for the benefit of shareholders which in return effectively mitigate the conflict between
shareholders and managers. Green (1984) [3] believed that there was a conflict of interest between the compa-
ny’s shareholders and the company’s creditors, especially in the key point of making investment and financing
decisions. But such behavior will allocate a gr eater part of investment risk to the creditor side, because the en-
terprise’s shareholders bear only limited liability and risk by law. Black-Scholes (1973) [4] hold that the con-
vertible bond financing may cause alternative assets problems: convertible bonds, which can act in the function
of options, may result in damage to the interests of creditors. Because shareholders will likely to maximize its
their interest at the expense of the interests of creditors. Jensen and Meckling (1976) [5] maintained that the
principal-agentrelationship is generally defined as a contract, and this contract exists between the principal
and the agent. The agent makes decision s within the specified rights guaranteed by the principal, and the pur-
pose of these decisions is to be able to realize the maximization of the interests of the principal. In general, since
the targets of the principal and the target of the agent are never exactly the same, then under the assumption of
rational economic man, the two sides will inevitably see deviation and conflicts of interest between them. And
such deviation and conflicts are due to the fundamental contradiction that both the group itself always seek to
maximize its interests. Stein (1992) [6] thought that under the circumstances of information asymmetry, inves-
tors would lose interest in equity investments. But the emergence of convertible bonds can alleviate this contra-
diction, because the convertible bond can be used as a delayed equity investments which allows investors to
learn how the company operates in a certain time after the issuance of convertible bonds and then decide wheth-
er or not to make the conversion. But it also can make the management group more inclined to invest the projects
which will increase the value of the company in order to attract investors to make the conversion decision.
Genming Zhang, Yonghua Fang (200 4) [7], Dong nian Wang (2006) [8], Li Zheng, Qinghua Wang (2006) [9]
used the similar research tools to study the effect of convertible bonds in terms of reducing agency costs. Based
their research on the two types of internal conflict which are conflict of interests between management and
shareholders of the enterprise and conflict of interest between shareholders of the enterprise and corporate cred-
itors, as was pointed out at the beginning of this paper, they discussed the unique role of convertible bonds in
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mitigating these two conflicts. Jia He, Hui Xia (2005) [10] made their analysis through the extended Stein’s
model, taking the factor that the shareholders are in the pursuit of the interests of being in charge into account, to
analyze how the business will make its financing options in this case. Ling Zhang, Feng Zheng (2005) [11]
made a great effort in the study of equity incentives. They believe that convertible bonds can fundamentally re-
duce the probability of corporate conflicts between shareholders and management in all aspects, because once
convertible bonds are applied to the equity incentive, it can mobilize management initiative to a large degree
thus reducing their offside behavior.
From the above studies we learned that both domestic researchers and f o reign researchers have found that the
cost of equity agency is directly affected by the equity structure and the enterprise management system. There
are Empirical studies conducted both at home and abroad to prove the above theory. Those European and
American researchers have made more thoroughly empirical studies, however, the ir study did not fully match
the theory. Their study helps to reduce the corporate agent fees and to increase operational efficiency, which
contributes mainly to deconstruct how the role of convertible bonds in the enterprise management construction
through theories and models, such in order to enrich their theory of convertible bonds in the company’s gover-
nance. While although the domestic industry researchers have done a lot of deep research to understand how the
convertible bonds plays a role in reducing agency costs of the enterprise, their specific measurements of the
agency costs do not have much d iffer ence, and there is little empirical studies to support their measurements.
The ultimate goal of this paper is to provide companies, especially listed companies with more evidence and
reference in terms of the financing methods and management structure.
3. Study Design
A) Sample S e lec tion
This study selected all listed companies who has issued convertible bonds during the time period from 2002 to
2013 as the initial sample, and the samples were screened by following the steps below: 1) Exclude financial
companies, due to their specialty; 2) exclude the companies with incomplete data during 2002-2013 years; and 3)
eliminate companies is sued du plicate convertible bonds. After the screening, the sample includes 79 listed com-
panies who issued convertible bonds. Financial indicators data herein from CSMA R financial research database,
the missing data in some individual years is from the China information site http//, the se-
curities regulatory commission ( CSRC) site and other sites. In this paper, the data processing of all adopt the
SPSS13.0 Wilcoxon signed-average rank test methods for statistical analysis.
B) Variable Definition s
There is no determined way to measure the agency cost neither At home nor abroad. Ang (2000) [12] used the
cost of sales rate and asset utilization r a te in their empirical research. In their research, cost of sales rate took the
sales cost rate of companies to the same scale with zero agency costs as the reference, thus a company’s agency
cost is calculated by using the company’s sales cost minus sales cost of company with zero agency costs. Since
the managers know well of the performance of the usage of assets to a large extend, thus they have a lot of mo-
tivation to use the asset for their own interests in the absence of incentives and shareholdersregulatory. For
example, they might give themselves more leisure time, conduct blind investment in order to get better perfor-
mance and so on. It is possible to measure agency cost by measuring ineffective use of assets in a company.
Singh and Davidson (2003) [13] calculated the agency cost by adding management expense ratio and financial
expense ratio to the formula of Ang (2000). However, domestic scholars Changjiang Lv, Yanqiu Zhang (2002)
[14] hold that the administrative costs is a reasonable measure of improper consumption of managers, so they
conducted their measurement by using administrative expenses, sales expensesutilization rate and the total as-
set utilization rate. Donghua Chen, Hsinyuan Chen and Wanhua Lin (2005) [15] simply measured the on-the-job
consumption on management levels while determining the agency cost.
The paper, based on previous studies, also used the management expense ratio (administrative expenses/main
business income) and total assets turnover (the main business income/average total assets) to measure the agen-
cy costs of listed companies. Because the agency cost is mainly caused by the fact that the shareholders could
not fully regulate the behaviors of managers, and the creditor cannot monitor the use of funds. As a result, im-
moral behaviors of managers such as on-the-job consumption, laziness on work and other unethical behavior of
managers and shareholdersmisconduct of investment like over-inves tmen t or under-investment which lead to
low efficiency in the use of assets may occur. Obviously, there is a positive correlation between manag ement
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expense ratio and agency costs, while asset turnover rate and agency costs change in the opposite direction, that
is, the lower the asset turnover rate, the higher the administrative costs.
C) Research Methods
Domestic scholars Xuefang Zhang, Chunjie Liu (2006) [16], Xianping Yuan, Dagang Ke (2006) [17], etc
used paired sample non-parametric test of Wilcoxon signed-average rank test in the study of performance
changes before and after the convertible bonds issued, so this paper will mainly draw on methods used by these
scholars to conduct the inspection of significant changes of agency cost s in those listed companies before and
after the issuance of convertible bonds. Wilocxon signed rank test method is used to inspect the difference value
of paired samples through a signed rank under a situation where the distribution of overall sample is unclear.
Wilcoxon signed-rank test evaluate the rank of paired samples in respect to their absolute value in descending
order. Then the corresponding score difference of each sign is noted by a plus notation or a minus notation re-
spectively. And then the ranks of two related undiff ere ntiated samples with a plus notation and a minus notation
were summed. If the value of the sum of the difference is very big, it shows a big difference between the two re-
lated samples. Wilcoxon signed rank test is a relatively high efficient method by utilizing plus and minus rank
and the difference value.
D) Empirical Research Results and Analysis
1) Statistics descriptive of agency cost indicators before and after the issuance of convertible bonds of the
In the general descriptive statistics study of the sample, the average is vulnerable to the worth of extreme,
while the median is relatively more stable, so this paper chose the median to do the comparison. Table 1 is a
median summary of convertible bonds management fee rate and the total turnover rate of the sample.
According to the description in Table 1, we found that the management expense ratio decreased when com-
paring the ration of issuing year of the convertible bonds with the previous year and the year after the release
with the issuing year, and the total turnover rate increased obviously. It supported the conclusion that the is-
suance of convertible bonds can reduce agency costs. Though a total turnover rate declined when the median of
the agency costs variable index of issuing year was compared with the previous year, evidence to support the
decline agency cost is more obvious on the whole.
2) Comparative Analysis of agency costs before and after the issuance of sample convertible bonds with Wil-
coxon signed rank test method
Management expense ratio and total asset turnover are designed as paired samples respectively in the time pe-
riod of three years (i.e., the year before the issuance, the year of the issuance and the year after the issuance).
Then Wilcoxon signed rank test method was used to do a differentiate inspection. The results are shown in
Table 2.
The results in Table 2 show that the manage ment expense ratio and total asset turnover have significant dif-
ferences between the issuing year and the previous year of the sample issuance of conv ertible bonds, while on ly
the total turnover rate there are significant different when the year after the issuing year was compared with the
issuing year.
Table 1. Descriptive statistics of sample convertible bonds median three-year before and after the issuance.
Year before issuing Issuing year Year after issuing
Management expense ratio (GEL) (%) 5.53342 5.25249 4.98463
Total assets turnover ratio (AZL) (%) 49.53871 52.09264 50.89246
Table 2. Wilcoxon test results for agency costs change before and after the sample issuance of convertible bonds.
Issuing year and the previous year The following year and issuing year
Management expense ratio (GEL) Z statistic 1.908 0.862
Asymp.Sig (2-tailed) 0.056* 0.389
Total assets turnover (AZL) Z statistic 0.615 1.015
Asymp.Sig (2-tailed) 0.038** 0.003***
Notes: a: *, **, *** in the table denote statistic at the 10%, 5% and 1% significance level is significant. b: Asymp.Sig listed in the table represents the
accompanied probability value of Z by statistics.
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3) Comparative analysis of agency cost grow t h before and after the samples issuance of convertible bonds
According to the results of the above study, there is pre liminary evidence to support that the company’s agent
coasts will be reduced after the issuance of the convertible bond, but in order to fully support the results, we
calculated the index growth rate to determine the increase or decrease of agency costs. The Growth formulas of
management fee rate and the total turnover rate of the sample are as follows:
The growth of management fee rate the year
management fee rate the yearmanagement fee rate last year100%
management fee rate last year
= ×
The growth of management fee rate next year
management fee rate next yearmanagement fee rate the year100%
management fee rate the year
= ×
The growth of total turnover rate the year
total turnover rate the yeartotal turnover rate last year100%
total turnover rate last year
= ×
It is clear from the definition of the calculation formula that the plus or minus sign of the growth rate of a
given indicator can explain this indicator’s growing or declining state before and after the issuance of the con-
vertible bonds. The results obtained according to the formula are as follows in Table 3.
Obviously, the management expense ratio declined in the year of the sample issuance of convertible bonds
compared with the previous year, the total turnover rate has increased, agency costs were significantly decreased.
In the following year of the issuance of the convertible bonds, the growth rate of management expense ratio is
greater than zero. The total asset turnover growth rate is 2.89% in the year after the issuance, which is less than
the growth rate of the total asset turnover in th e is s uing year, which may be due to the less effective governance
function of convertible bonds in the year after the issuance compared to the issuing year.
Genming zhang, Yonghua fang (2004) [7], Dongnian Wang (2006) [8], Li Zheng, Qinghua Wang (200 6) [9]
analyzed how convertible bond decreased agency cost between shareholders and creditors, shareholders and
managers. The empirical results of this article which is consistent with the theory research conclusions of pre-
decessors, support the theory on empiricl side that convertible bond can reduce agency cost.
Based on a few empirical researches on the theory that convertible bond can reduce agency cost, the indices
of agency cost and statistical analysis used in this paper are probably not so perfect, and we wish that more ac-
curate indices can be digged up in later work. At the same time, the development of convertible bond financing
in China’s capital market came later, which lead to the selection of data is not large, and the certain err o r can
hardly be avoided. Due to space constraints, just the result of the theory that convertible bond can reduce agency
cost are studied, and no mechanisms of action of the result are analyzed in this paper, which can be used as a re-
search direction to continue in future.
4. Conclusion and Recommendations
In this paper, the median of the management fee rate and the total asset turnover rate wer e utilized in the descrip-
tive statistic analysis. Through Wilcoxon average signed rank test, sample ag ency cost variables have undergone
Table 3. Growth rate statistics of agency cost before and after the issuance of convertible bonds.
Management expense ratio growth rate (GELZ) Total asset turnover growth rate(AZLZ)
Growth rate in issuing year 4.38% 5.32%
Growth rate in the following year 1.09% 2.89%
Note: The data obtained in the table are medians of variable growth rates.
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the paired test, and finally the judgment was made by calculating the growth rate of the variab le index. After this
comprehensive examination of the effect that the issuance of convertible bonds of listed companies has on
agency costs before and after the issuance in China, a con clusion can be drawn: agency costs of listed companies
will indeed change before and after the issuance of convertible bonds, which has a basic downward trend, thus
support, to a certain extent, the theoretical study on the function of convertible bond to reduce agency costs of
the company. Thus, the convertible bonds can be used as a priority of financing source to refinance in the case
of a listed company which has well designed the terms of the issuance of convertible bonds. While besides its
role in solving the financing problem that a company faces, convertible bonds can also alleviate, to some extent,
the agency conflicts between shareholders and creditors, between shareholders and management, and can reduce
agency costs and improve the company’s governance structure.
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