• Division Buyout and Refinancing of Event Risk Covenant Bonds: Evidence from the Long-Term Stock Performance

      Tewari, Manish; The College at Brockport (2013-05-17)
      The focus of this paper is to assess the long-term common stock performance of the parent firms that underwent divisional buyout (DBO) and had event risk covenant (ERC) bonds outstanding at the announcement of the DBO. The final sample of 46 parent firms exhibit a common characteristic where all the ERC bonds were redeemed (either called above par or put on the firm at par) or restructured at a higher cost to the firm around DBO announcement date due to the presence of ERCs. ERCs are triggered since the parent firms that divest their assets through a DBO reveal future cash flow volatility, which has potential to lower the value of existing bonds. This refunding of the bonds leads to costly refinancing for the parent firms, which has long-term implications. I find significantly negative cumulative abnormal returns at the issue date of the ERC bonds for these firms due to potential managerial entrenchment and foregone transfer of wealth from bondholders to stockholders. Consistent with the finance literature, I find significantly positive cumulative abnormal returns for parent firms at the announcement of the DBO. These positive short-term returns at the announcement do not translate into long-term positive returns. The common stock of these parent firms significantly underperforms the market over the periods three, four, and five years after the DBO date. This dichotomy can be attributed to the security market overreaction to the announcement of DBO. The long-term underperformance can be attributed to the costly refinancing of the ERC bonds.
    • Division Buyout and Refinancing of Event Risk Covenant Bonds: Evidence from the Long-Term Stock Performance

      Tewari, Manish; The College at Brockport (2013-05-17)
      The focus of this paper is to assess the long-term common stock performance of the parent firms that underwent divisional buyout (DBO) and had event risk covenant (ERC) bonds outstanding at the announcement of the DBO. The final sample of 46 parent firms exhibit a common characteristic where all the ERC bonds were redeemed (either called above par or put on the firm at par) or restructured at a higher cost to the firm around DBO announcement date due to the presence of ERCs. ERCs are triggered since the parent firms that divest their assets through a DBO reveal future cash flow volatility, which has potential to lower the value of existing bonds. This refunding of the bonds leads to costly refinancing for the parent firms, which has long-term implications. I find significantly negative cumulative abnormal returns at the issue date of the ERC bonds for these firms due to potential managerial entrenchment and foregone transfer of wealth from bondholders to stockholders. Consistent with the finance literature, I find significantly positive cumulative abnormal returns for parent firms at the announcement of the DBO. These positive short-term returns at the announcement do not translate into long-term positive returns. The common stock of these parent firms significantly underperforms the market over the periods three, four, and five years after the DBO date. This dichotomy can be attributed to the security market overreaction to the announcement of DBO. The long-term underperformance can be attributed to the costly refinancing of the ERC bonds.
    • Effectiveness of Event Risk Covenants in High Yield Bonds: Evidence from Long-Run Stock Performance

      Tewari, Manish; Ramanlal, Pradipkumar; The College at Brockport; University of Central Florida (2012-01-01)
      We examine the post-issue long-run performance of the common stock of the firms issuing nonconvertible high yield bonds with event risk covenants (ERCs) over the period five years after the issue date. Using Fama French (1993) four factor regression model to analyze a sample of 217 issues issued between 1986 and 2004, we find statistically and economically significant monthly average abnormal returns between 0.36% and 0.55%, which compounds to 24% to 39% over the five year period. The evidence suggests strong long-run overperformance after the issuance. This result is in contrast to the evidence of underperformance after the straight debt issues (Speiss and Affleck-Graves, 1999). Our results support the evidence that the ERCs in bonds issued by the firms closer to financial distress or with low credit rating, help significantly reduce the agency problem between the common stockholders and the bondholders resulting in direct cost benefit to the firm in terms of reduced yields. This benefit seems to far outweigh the costs to the stockholders in terms of agency cost of potential management entrenchment and/or potential loss of takeover premium. The net result is the higher returns for the shareholders. The full impact of this benefit is only realized in the long-run.
    • Effectiveness of Event Risk Covenants in High Yield Bonds: Evidence from Long-Run Stock Performance

      Tewari, Manish; Ramanlal, Pradipkumar; The College at Brockport; University of Central Florida (2012-01-01)
      We examine the post-issue long-run performance of the common stock of the firms issuing nonconvertible high yield bonds with event risk covenants (ERCs) over the period five years after the issue date. Using Fama French (1993) four factor regression model to analyze a sample of 217 issues issued between 1986 and 2004, we find statistically and economically significant monthly average abnormal returns between 0.36% and 0.55%, which compounds to 24% to 39% over the five year period. The evidence suggests strong long-run overperformance after the issuance. This result is in contrast to the evidence of underperformance after the straight debt issues (Speiss and Affleck-Graves, 1999). Our results support the evidence that the ERCs in bonds issued by the firms closer to financial distress or with low credit rating, help significantly reduce the agency problem between the common stockholders and the bondholders resulting in direct cost benefit to the firm in terms of reduced yields. This benefit seems to far outweigh the costs to the stockholders in terms of agency cost of potential management entrenchment and/or potential loss of takeover premium. The net result is the higher returns for the shareholders. The full impact of this benefit is only realized in the long-run.
    • Is the Put Option in U.S. Structured Bonds Good for Both Bondholders and Stockholders?

      Tewari, Manish; Ramanlal, Pradipkumar; The College at Brockport; University of Central Florida (2010-01-01)
      The recent financial crisis has brought into spotlight various financially engineered products, their design parameters, and the impact of these design parameters on the bondholders and the common stockholders. We analyze the common stock performance of 134 firms issuing the callable-puttable bonds, a structured derivative security, issued between 1977 and 2005. We focus our study on the common stock performance of the issuing firms around the issue date and the put date. We use the Fama French (1993) four factor regression model to estimate the common stock performance of the issuing firms two years before and after the issue and the put date. We find that these firms underperform the market throughout. The firms perform worse after the issue date but improve their performance as we get closer to the put date. We find strong evidence that the presence of the put option in these securities provides protection to the bondholders as well as improved returns to the common stockholders. The deferred put option can mitigate the agency problem between the stockholders and the bondholders.
    • Is the Put Option in U.S. Structured Bonds Good for Both Bondholders and Stockholders?

      Tewari, Manish; Ramanlal, Pradipkumar; The College at Brockport; University of Central Florida (2010-01-01)
      The recent financial crisis has brought into spotlight various financially engineered products, their design parameters, and the impact of these design parameters on the bondholders and the common stockholders. We analyze the common stock performance of 134 firms issuing the callable-puttable bonds, a structured derivative security, issued between 1977 and 2005. We focus our study on the common stock performance of the issuing firms around the issue date and the put date. We use the Fama French (1993) four factor regression model to estimate the common stock performance of the issuing firms two years before and after the issue and the put date. We find that these firms underperform the market throughout. The firms perform worse after the issue date but improve their performance as we get closer to the put date. We find strong evidence that the presence of the put option in these securities provides protection to the bondholders as well as improved returns to the common stockholders. The deferred put option can mitigate the agency problem between the stockholders and the bondholders.