Devaluing Bondholder Rights
69 Pages Posted: 22 Oct 2019 Last revised: 1 Sep 2020
Date Written: October 21, 2019
Totaling in excess of $100 billion dollars in transactions annually, debt buybacks allow a company to repurchase bonds from investors, rewriting bargains and stripping away creditor control rights in the process. This Article shows that regulation systematically under-protects bondholders in the context of debt buybacks. It makes three points. First, bondholders confront information asymmetries that enable issuers to buy back creditor claims cheaply. Regulation imposes near negligible requirements on issuers to disclose information about the transaction. Lacking fiduciary protection, bondholder interests are vulnerable to being devalued by issuers in the interests of securing gains for shareholders and managers. Second, buybacks diminish the power of creditor control rights. Alongside information asymmetries, bondholders confront coordination costs and tight deadlines within which to evaluate a buyback and amendments to bond covenants. This pressure gives issuers incentive to underprice creditor control rights. Bondholders will not act where the gains of agitation will be less than the cost of information gathering, coordination, valuation and action. By strategically underpricing a buyback by an amount approximating these transaction costs, an issuer can pocket the difference between the price paid for the claim and that which should have been paid to bondholders for their bargain. Third, debt buybacks can allow one set of creditors (notably, banks) to extract value from bondholders. By pushing a borrower to buy back bond claims cheaply and improving the overall health of the balance sheet, banks (usually with greater individual exposure through loans) can increase their chances of being repaid. They can also acquire a more powerful voice in the borrower’s internal governance by muting that of bondholders. In concluding, this Article offers two proposals to bolster bondholder protection, advocating for greater disclosure and contractual fixes to safeguard the value of claims. With Covid-19’s devastating effects on corporate balance sheets, buybacks will assume even greater significance as firms try and restructure. These proposals help to preserve the welfare of investors in this process, protect their longer-term confidence in debt capital allocation.
Keywords: debt, buybacks, creditors, bankruptcy, Chapter 11, restructuring, investor protection, opportunism, shareholder primacy, negotiation
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