Which of the following is a disadvantage of convertibles for issuers?

Which of the following is a disadvantage of convertibles for issuers?

• A. Obligation to pay a higher coupon
• B. Eventual dilution of shares
• C. Permanent asset acquisition
• D. Clearing process complications

Answer: (B)

The disadvantage of convertibles for issuers primarily lies in the eventual dilution of shares. When a company issues convertible securities, it grants the holder the right to convert their bonds or preferred stock into a predetermined number of common shares. Upon conversion, the total number of outstanding shares increases, which can dilute the ownership stake of existing shareholders. This dilution can negatively impact earnings per share and may lead to a decrease in the market value of the company’s shares, as the same amount of earnings is spread out over a larger number of shares. Understanding this is key for issuers when considering the impact of convertible securities on their capital structure and shareholder value. While other factors such as the obligation to pay a higher coupon or complications in the clearing process may present challenges, the direct impact of share dilution on existing shareholders is a more significant corporate governance concern for issuers.

The disadvantage of convertibles for issuers primarily lies in the eventual dilution of shares. When a company issues convertible securities, it grants the holder the right to convert their bonds or preferred stock into a predetermined number of common shares. Upon conversion, the total number of outstanding shares increases, which can dilute the ownership stake of existing shareholders. This dilution can negatively impact earnings per share and may lead to a decrease in the market value of the company’s shares, as the same amount of earnings is spread out over a larger number of shares.

Understanding this is key for issuers when considering the impact of convertible securities on their capital structure and shareholder value. While other factors such as the obligation to pay a higher coupon or complications in the clearing process may present challenges, the direct impact of share dilution on existing shareholders is a more significant corporate governance concern for issuers.