A stock price decline in response to a company’s decision to force conversion of convertible securities reflects the effects of a potential change in corporate cash flows. In particular, analysis of several possible causes of the price response indicates that only after the tax effect—that is, the expected reduction in the company’s interest expense tax shield—is a significant factor. The market does not appear to anticipate a redistribution of wealth from common stockholders to holders of preferred stock and debt claims or to respond to a reduction in earnings per share resulting from an increase in shares outstanding.

It is unclear, however, whether the price decline reflects the market’s perception of the call’s effect on corporate taxes per se, or whether the market interprets the call as conveying information about earnings prospects. In the latter case, the market interprets the call announcement as a proper response by company management to an internal downward revision in firm earnings; the call is thus not contrary to shareholder interests.