Year:    1977

Author:    Ludwig, Wolfgang

Credit and Capital Markets – Kredit und Kapital, Vol. 10 (1977), Iss. 1 : pp. 91–116

Abstract

Anti-Watering Clauses for Convertible Bonds

Since the 1964 issue of Siemens’ convertible bonds, the terms of convertible bonds include so-called anti-watering clauses for the event of intervening capital increases. On the basis of a comparison with the economically indicated measures, the most frequent forms of protection against watering found in the terms of loans are assessed. The effects of different protective provisions on the success of investments of convertible bond holders are illustrated by the example of the 1964 Siemens’ convertible bond issue. The economically indicated procedure for affording protection against watering consists in simultaneously increasing the number of shares obtainable for the convertible bond and reducing the subscription or conversion price. The full participation of the convertible bond holder in the capital increase entails systematic prejudicial treatment of the shareholders, the severity of which increases as the probability of profitable exercise of subscription or conversion rights declines. A reduction of the subscription or conversion price by the value of the subscription right entails a general worsening of the position of the convertible bondholders. Formulized reduction of the subscription price when the market share price level is higher than the subscription price results in a disadvantage for the bondholders which is even greater than in the case of a reduction of the value of the subscription right. In the case of a low market share price level compared to the subscription price, no unequivocal statement can be made regarding formulized adjustment. The systematic preference or discrimination of the bondholders in the event of participation in the capital increase or reduction of the subscription price can be eliminated by a combination of the two measures. The combination ratio depends in this case on the estimate of the value of the conversion or subscription rights. The necessity of improving protection against watering becomes evident on considering the shift of wealth in the amount of over DM 4 million at the expense of the holders of the 1964 Siemens’ convertible bonds.