Valuation of convertible preferred shares with focus on Korean market

Abstract

This thesis attempts to identify fundamental factors determining valuation of convertible preferred shares. After clearly reviewing characteristics of the preferred shares, we reviewed the literature and found that there are three fundamental factors for the valuation of convertible preferred shares; dividend guarantee, voting rights and convertibility. To test the three fundamental factors, we developed six hypotheses focusing on dividends, block holding shares, time to conversion, leverage, market yield spread and market returns. To estimate the value of the preferred shares, we structured two ordinary least squares (OLS) models setting dependent variables as preferred share premium (Model 1: PS premium) and quarterly dividend yield of preferred shares (Model 2: QDYP), respectively. Based on F-stat and adjusted R-squared, Model 1 best explains the variations of the preferred share premium and fits well to the data sets. This thesis found that there are significant values for convertibility and voting rights and these values are discounted by time and getting more valuable as approaching their conversion dates. Regarding the time value of convertibility and voting rights, we have found there are interesting arbitrage trade opportunities between the common shares and the preferred shares. We also concluded that there are significant values for cumulative dividends. By comparing values among common shares, convertible preferred shares and non-convertible preferred shares, we calculated that values of voting rights and dividend cumulativeness are 43% and 39% of common shares, respectively. This thesis provides new evidences for the value of convertibility, the value of voting rights and the dividend guarantee. We believe that these considerable corporate governance related values are largely due to weak legal protection and idiosyncratic corporate governance structure in Korea. Controlling growth, volatility, liquidity, size, share buyback, rate environment and crises, we get significant regression results suggesting that on average the convertible preferred share premium is positively associated with leverage and time to conversion. Surprisingly, the convertible preferred share premium is negatively associated with the dividend yields. This is probably due to the voting rights recovery upon the dividend omission. For block holding, the bond-like non-convertible preferred shares have shown positive significant relations. This bondness of non-convertible preferred shares are more apparent with significant negative coefficients for the market yield spread and the market return. Additionally, we also documented a liquidity premium for the valuation of preferred shares. We think exemption of capital gains tax in Korea makes easiness to sell very valuable.