High-Yield ('Junk') Bonds As Investments and As Financial Tools
William A. Klein
University of California, Los Angeles (UCLA) - School of Law
Cardozo Law Review, Vol. 19, No. 2 (1997) (Symposium on the Essays of Warren Buffett).
High-yield ("junk") bonds acquired a bad name when used in the late 1980s to finance takeover transactions that left target corporations with an excessive risk of insolvency. The tarnished reputation of these instruments is largely unde- served. High-yield bonds have proved useful, as an alterna- tive to bank and other forms of financing, for "emerging" firms. Their use, as opposed to new equity financing, should be taken as a signal of optimism. Excessive debt may create perverse incentives and a high risk of insolvency with its attendant costs, but these problems should be attributed to faulty regulation or to the infirmities of our system for insolvency reorganization. If options can be thought of as junior (subordinated) equity, high-yield bonds can be thought of as senior equity. If we can tolerate the riskiness of common stock and of options, we should have no difficulty with the riskiness of high-yield bonds.
JEL Classification: G32
Date posted: May 12, 1997
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