The Defeasance of Control Rights

46 Pages Posted: 9 Aug 2010 Last revised: 4 Sep 2010

See all articles by Carsten Bienz

Carsten Bienz

Norwegian School of Economics (NHH)

Antoine Faure-Grimaud

London School of Economics; Centre for Economic Policy Research (CEPR)

Zsuzsanna Fluck

Michigan State University - Department of Finance

Date Written: August 30, 2010

Abstract

We analyze one frequently used clause in public bonds called covenant defeasance. Covenant defeasance allows the bond issuer to remove all of the bond's covenants by placing the remaining outstanding payments with a trustee in an escrow account to be paid out on schedule. Bond covenants are predominantly noncontingent, action-limiting covenants. By giving the issuer an option to remove covenants, noncontingent control rights can be made state-contingent even when no interim signals are available. We provide a theoretical justification for covenant defeasance and show empirically that such a clause allows for the inclusion of more covenants in public bond issues. In line with the model's prediction, our empirical analysis documents a 13-25 basis points premium for defeasible bonds. This premium amounts to an annual saving of about $1m per year, or $11m over the lifetime of an average bond.

Keywords: Bonds, Covenants, Defeasance, Renegotiation

JEL Classification: G32, D86, G12

Suggested Citation

Bienz, Carsten and Faure-Grimaud, Antoine and Fluck, Zsuzsanna, The Defeasance of Control Rights (August 30, 2010). Available at SSRN: https://ssrn.com/abstract=1656089 or http://dx.doi.org/10.2139/ssrn.1656089

Carsten Bienz (Contact Author)

Norwegian School of Economics (NHH) ( email )

Helleveien 30
Bergen
Norway

Antoine Faure-Grimaud

London School of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6041 (Phone)
+44 20 7955 6887 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Zsuzsanna Fluck

Michigan State University - Department of Finance ( email )

Eli Broad Graduate School of Management
315 Eppley Center
East Lansing, MI 48824-1122
United States
517-353-3019 (Phone)
517-432-1080 (Fax)

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