The Value of Creditor Control in Corporate Bonds
London Business School
Edith S. Hotchkiss
Boston College - Carroll School of Management
Boston College - Department of Finance
November 10, 2014
This paper analyzes the impact on corporate bond pricing of the shift of control rights from shareholders to creditors as firm credit quality declines. Specifically, we propose a new measure to demonstrate the premium in bond prices that is related to creditor control. The main insight for our methodology is that credit default swap (CDS) prices reflect the cash flows of the underlying bonds, but not the control rights. We estimate the premium in bond prices as the difference in the bond price and an equivalent synthetic bond without control rights that is constructed using CDS contracts. Empirically, we find this premium increases as firm credit quality decreases and around important credit events such as defaults, bankruptcies, and covenant violations; the increase is greatest for bonds most pivotal to changes in control. Changes in bond and CDS liquidity do not appear to drive increases in the premium.
Number of Pages in PDF File: 64
Keywords: Creditor control, Credit default swap (CDS), Distress, Default, Bankruptcy, Covenant violation, Liquidity, Corporate bonds
JEL Classification: G13, G33, G34working papers series
Date posted: March 7, 2014 ; Last revised: November 12, 2014
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