A debt-equity swap is a way to restructure some of the finances of a corporation so that it can better position itself in terms of its financial standing. In the case of a debt-equity swap, the lender is offered shares of common stock in exchange for existing bonds. The number of shares of stock awarded is determined by the amount of outstanding debt and the stock's value.
A debt-equity swap is attractive to companies for a number of reasons. Most importantly, some companies may need to boost their bond ratings. Changing the debt-equity ratio in favor of equity may be the easiest way to do this. Improving a debt-equity ratio is important for some companies, especially if it is perceived that their debt amounts are getting too high. In such cases, whether it is a bond or bank loan, companies have an incentive to improve this number.
While a debt-equity swap is an attractive option for the companies offering the trade, investors may or may not wish to engage in a debt-equity swap. Investors may each have their own reasons for choosing to agree to swap or not. In some cases, the investors may find the higher likelihood of a bond payment attractive, as opposed to a dividend payment, which is less likely. In other instances, an investor may appreciate the switch, wanting the ownership stake and voting rights that come along with stock ownership.
For corporations that really want to entice bondholders into a debt-equity swap, they may offer something more than the value of the outstanding debt. For example, if a bondholder has $10,000 US Dollars (USD) worth of outstanding bonds, he or she may be offered $15,000 (USD) worth of common stock. This type of a deal may be too much for some bondholders to resist.
In addition to a debt-equity swap, the opposite may also be done. This is called an equity-debt swap. It is very similar to a debt-equity swap, with the difference, of course, being that stock is traded for bond debt. This offers an investor a chance at receiving bond payments but takes away any ownership stake they have in a corporation.