By Olga Usvyatsky

Convertible debt is a hybrid security that combines elements of debt and equity. When investors buy convertible debt, they also acquire the right to convert that debt into equity shares at a specified price (the “conversion price”)  in the debt agreement.

As Calcbench explained in a post from January about convertible debt, the interest rate on convertible debt is generally lower than rates paid on traditional debt. Hence convertible debt’s popularity; companies can use it to keep their interest expense down. On the other hand, when that debt does convert into equity, that “dilution event” pushes down the value of shares for all shareholders (because more shares now exist).

Equity investors need to understand the terms of such deals thoroughly, so in this article let’s expand on that analysis and delve into supplemental hedging transactions that limit potential dilution.

First, some background. Companies that issue convertible bonds sometimes purchase a call option on their own stock, with the strike price equal to conversion price of the bond and a “cap” price that limits the exposure of the counterparty selling the option. This is known as a “capped call transaction.”

According to a Barron’s article from December, smaller companies were historically more inclined to use convertible debt than large ones. A recent Bloomberg article, however, noted a shift where large companies are now tapping into the convertible debt market too, because interest rates are staying stubbornly high.

So what does all that look like in practice? What information can we glean from company filings?

Digging Into the Data

We identified 37 S&P companies with outstanding convertible debt balances as of Dec. 31, 2023. Twelve of those companies (that is, one-third of the sample) also entered into dilution-limiting hedges at the same time they issued the debt. (Technically a company enters into two transactions to achieve this: the capped call and the hedge. Since both transactions have similar economic substance we’re referring to them here collectively as “dilution-limiting hedges.”)

The below spreadsheet is a sample of the data. 

Let’s look at an excerpt from Uber’s 2023 10-K, which illustrates the terms of a capped call transaction:

“In connection with the issuance of the 2028 Convertible Notes, we entered into privately negotiated capped call transactions (“the Capped Calls”) with certain of the initial purchasers of the 2028 Convertible Notes or their respective affiliates (the “option counterparties”) at a cost of approximately $141 million. The Capped Calls cover, subject to anti-dilution adjustments, the number of shares of our common stock initially underlying the 2028 Convertible Notes. By entering into the Capped Calls, we expect to reduce the potential dilution to our common stock (or, in the event a conversion of the 2028 Convertible Notes is settled in cash, to reduce our cash payment obligation) in the event that at the time of conversion of the 2028 Convertible Notes the trading price of our common stock price exceeds the conversion price of the 2028 Convertible Notes.

The initial cap price of the Capped Calls was approximately $95.81 per share, which represents a premium of 75% over the last reported sale price of our common stock of $54.75 on the New York Stock Exchange on November 20, 2023, and is subject to certain adjustments under the terms of the Capped Calls.”

Uber’s 2028 convertible notes, issued in November 2023, had a face value of $1.73 billion, carried an interest rate of 0.875 percent, and had a conversion price of $72.54 per share. At the time Uber issued the debt, shares were trading around $54.

The capped call transaction increases the dilution threshold from $72.54 to $95.81 per share — but at a steep up-front cost of $141 million, or roughly 8 percent of the $1.73 billion debt proceeds. (That said, Uber’s hedging costs appear comparable to those of other companies; the median and the average in our sample are 8.13 percent and 8.78 percent, respectively.)

All else being equal, debt investors would favor security with a lower conversion price and equity investors would prefer lower potential dilution. But is paying the high up-front costs of hedging a better, more economically sound option than other anti-dilution mechanisms — for instance, repurchasing shares in the future?

You could argue that buying a call option on the company’s own stock may reflect management’s optimism about the stock’s growth potential. Then again, it’s not easy to discern whether managerial beliefs are astute forecasts or excessively optimistic projections that lead to over-hedging.

One academic paper finds that convertible debt issuances with concurrent dilution-limited transactions are associated with less negative market returns than “plain vanilla” convertible issuances. That research, however, relied on transactions dated from 2000 to 2010; it’s not clear whether this relationship would still hold in today’s environment.

Moreover, the paper only looked at the results in the short-term post-issuance window of up to five days. Evaluating longer-term performance was outside the scope of its work.

As of the second week of March, Uber’s stock was trading around $78 — slightly above the initial conversion price of $72.54. We cannot forecast where the stock will be at the debt maturity in 2028, and in any case, anecdotal evidence is not a viable trading strategy.

For the readers interested in the data, convertible debt, capped calls, and note hedges are easy to find using Calcbench’s Interactive Disclosure and Multi-Company pages.

Editor’s note: Olga Usvyatsky is a long-time accounting researcher and occasional contributor to the Calcbench blog. Usvyatsky enjoys raising interesting questions about financial disclosures, and can be reached at


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