Conversion Ratio – Definition

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Conversion Ratio Definition

The conversion ratio refers to the number of shares that is obtainable after converting a certain denomination or convertible security into common shares. Hence, the conversion ration outlines the sum of common shares that was received or obtained after the conversion of a number of convertible securities.

Conversion ratio is calculated by dividing the convertible securities denomination by the conversion price. It shows the number of common shares an investor can obtain when a convertible security is exchanged for common share. This ratio represents the number of common shares that were exchanged for convertible securities.

A Little More on What is Conversion Ratio

In a stock exchange market, investors and shareholders make varying decisions at specific times. Also, securities, stocks and bonds are exchanged under certain conditions made by the issuer and agreed to by the purchaser. For instance, a holder of convertible bonds or securities can decide to exchange the bonds for common shares or at a certain fee paid to the joint stock company. The conversion ratio describes the number of common shares that such a holder can obtain after the conversion or exchange of the convertible securities.

The most common conversion is that of exchanging convertible securities for common shares of a company. However, the dividend yield of convertible preferred stocks tend to be lower than that of other preferred stocks. Also, investors that invest in convertible preferred stocks do so because of the benefits they will derive from it such as converting common stock to share lucrative profits.

Corporate bonds can also be exchanged for common shares based on a corporate decision and an agreed price by bondholders. This type of conversion is also characterised by conversion ratio and conversion price which are often fixed. In this type of market agreement, conversion ratio refers to the number of shares that can be converted into common shares for each corporate bond. The conversion of corporate bonds to ordinary shares benefit both the bond issuer and the bondholder. That is, there is always conversion price agreed on based on the bond face value and conversion ratio.

Furthermore, a company’s shareholders can decide to convert the preferred shares of the company into ordinary shares, in this case, certain conditions must be met by the investors interested in the exchange. This type of conversion is often held at a beneficial time that permits investors to partake in a firm’s business decisions.  Also, this type of exchange or conversion is enabled by two accounting principles which are;

  1. The conversion of preferred shares can reduce retained earnings but not increase it.
  2. In this type of exchange, the entire share capital of the preferred shares must be transferred to the common share capital without any remainder.

References for Conversion Ratio

Academic Research for Conversion Ratio

Convertible bonds as” back door” equity financing, Stein, J. C. (1992). National Bureau of Economic Research.

Informative conversion ratios: A signalling approach, Kim, Y. O. (1990). Journal of Financial and Quantitative Analysis, 25(2), 229-243.

Stage financing and the role of convertible debt, Cornelli, F., & Yosha, O. (1997).

Convertible debt issuance, capital structure change and financing-related information: Some new evidence, Dann, L. Y., & Mikkelson, W. H. (1984). Journal of Financial Economics, 13(2), 157-186.

Convertible bonds: Valuation and optimal strategies for call and conversion, Brennan, M. J., & Schwartz, E. S. (1977). The Journal of Finance, 32(5), 1699-1715.

Stage financing and the role of convertible securities, Cornelli, F., & Yosha, O. (2003). The Review of Economic Studies, 70(1), 1-32.

Efficient financing under asymmetric information, Brennan, M., & Kraus, A. (1987). The Journal of Finance, 42(5), 1225-1243.

Industry conditions, growth opportunities and market reactions to convertible debt financing decisions, Lewis, C. M., Rogalski, R. J., & Seward, J. K. (2003).Journal of Banking & Finance, 27(1), 153-181.

securities and venture capital finance, Schmidt, K. M. (2003). The Journal of Finance, 58(3), 1139-1166.

Analyzing convertible bonds, Brennan, M. J., & Schwartz, E. S. (1980). Journal of Financial and Quantitative analysis, 15(4), 907-929.

An analysis of convertible debentures: Theory and some empirical evidence, Brigham, E. F. (1966). The Journal of Finance, 21(1), 35-54.

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