The Price Effects of Event Risk Protection: The Results from a Natural Experiment
Karl S. Okamoto
Drexel University School of Law
David J. Pedersen
Rutgers, The State University of New Jersey - Rutgers University, Camden
Natalie Bucciarelli Pedersen
Drexel University - Earle Mack School of Law
July 16, 2010
5th Annual Conference on Empirical Legal Studies Paper
Prior studies have generally agreed that bond prices reflect both the event risk faced by the holders of a particular issuer’s debt securities and the degree of protection from event risk contained within the terms of the bond. Therefore, it has been found that bonds without event risk protection command a premium over comparable bonds with “change in control puts” or similar protective covenants. Although prior studies have reached this common conclusion, each has struggled with a common problem. The decision to include protective covenants is endogenous. Bonds facing the highest event risk are likely to be those for which event risk protection is most highly valued. Therefore a determination of the pricing effect of event risk protection must somehow control for the differing degree of event risk faced by the different bonds included in any given study’s sample. While various proxies for the likelihood of an event, a leveraged buyout or recapitalization, have been developed, they are by their nature imprecise. A recent event, a series of court decisions regarding the proposed leveraged buyout of Bell Canada, the largest LBO transaction announced in history, provides a natural experiment for evaluating the pricing effect of event risk protection in corporate bonds that avoids the endogeniety problem. We report the results of that experiment in this paper.
Number of Pages in PDF File: 37
Keywords: bondholder expropriation, change-in-control covenant, event risk, poison puts
JEL Classification: G24, G30, G32, G34working papers series
Date posted: July 17, 2010
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