Improving the prevention of environmental risks with convertible bonds |
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Authors: | Andr Schmitt Sandrine Spaeter |
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Institution: | aLARGE, Université Louis Pasteur, 61, Avenue de la Forêt Noire, F-67085 Strasbourg Cedex, France;bBETA, Université Louis Pasteur, 61, Avenue de la Forêt Noire, F-67 085 Strasbourg Cedex, France |
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Abstract: | This paper considers a limited liability firm that needs external funds in order to invest in an activity that presents an environmental risk for the Society. When the firm's risk-reducing activities cannot be observed by the lenders, we show that the issue of convertible bonds can create incentives to improve prevention. Convertible bonds allow the holder to exchange his bonds for a fixed number of the firm's shares. The use of such hybrid securities could either complement or be an alternative to the American CERCLA legislation about lender extended liability. We define an optimal convertible bond contract that induces unchanged economic profits for the bank, more prevention and higher expected net revenues for the firm and a higher expected social welfare than with standard debt. Our results hold true both with and without extended liability. |
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Keywords: | Moral hazard Environmental risk Limited liability Prevention Convertible bond |
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