In other words, the probability of getting caught mimicking does not vary across firms in each class.
If we combine our assumptions, that the costs of financial distress vary across firms and the probability that getting caught increases with the quality gap, then we see that a low(er)-quality firm, Firm j, can choose to mimic a high(er)-quality firm, Firm i, by setting a low conversion ratio if the benefits of mimicking exceed the expected costs.
We argue that if mimicking occurs, it should occur between firms that are not too far apart in the quality spectrum.
We expect mimicking to occur when the quality of the mimicking firm is relatively close to that of the mimicked firm, because the existence of information asymmetry suggests that the market may be unaware of the true quality of the firm.
This study adds to the literature by examining whether firms issuing convertible bonds that are not converted into equity were mimicking when they originally issued the convertible bond.
These firms can get away with mimicking if firm performance increases subsequent to the offer, such that the bonds become in the money.
For mimicking to be present, lower-quality firms must pose as (relatively) higher-quality firms.
While issue characteristics and convertible bond contract terms should be similar for mimicking and non-mimicking firms, the mimicking firms are usually riskier than those that truthfully reveal firm quality.
The first two hypotheses jointly validate mimicking behavior on the part of some firms.
Since the subset of mimicking firms announce convertible bonds with conversion premiums (conversion ratios) that are higher (lower) than that required to signal the firm's true quality, the market should be pleasantly surprised by the announcement.
Section II presents evidence on mimicking, which is followed by an examination of the market's reaction to offer announcements by the two subsamples in Section III.
Our purpose is to determine at offer announcement whether firms issuing convertible bonds that do not infuse the firm's capital structure with equity are mimicking higher-quality firms.
Evidence consistent with our first two hypotheses should validate mimicking behavior if firms issued convertible bonds that did not result in an infusion of equity subsequent to the offer.