Debt Buybacks and the Myth of Creditor Power
67 Pages Posted: 22 Oct 2019 Last revised: 15 Feb 2020
Date Written: October 21, 2019
Scholars have developed an extensive body of research examining share buybacks and their significance for policy and economic welfare. Little attention, however, has focused on debt buybacks despite their ability to rewrite bargains and strip away creditor control rights in the process. Between 2004-2017, approximately $1.9 trillion worth of corporate debt was subject to a buyback, highlighting the importance of this technique for issuer-bondholder relations and firm capital structure.
This Article shows that regulation systematically fails to protect creditors in the context of debt buybacks. It makes three points. First, bondholders confront information asymmetries that enable issuers to buy back creditor claims cheaply. While disclosure accompanies the extension of debt, buybacks are much less revelatory, with regulation imposing negligible requirements on issuers to provide information. Lacking fiduciary protection, creditors are vulnerable to being shortchanged by issuers in the interests of securing gains for shareholders and managers. Second, buybacks diminish the power of creditor control rights. Alongside limited disclosure, bondholders confront coordination challenges and tight deadlines within which to evaluate a buyback and amendments to bond covenants. This difficulty gives issuers added incentive to underprice creditor controls. Bondholders will not act where the gains 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 in recognition of their bargain. Third, debt buybacks open up the possibility of one set of creditors (notably, banks) extracting 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 proposals to bolster bondholder protection, advocating for greater disclosure and contractual fixes to safeguard the value of claims. With a swath of Main Street savings managed by bond funds, these steps help to preserve the welfare of ultimate investors and reduce the cost of capital in securities markets.
Keywords: debt, buybacks, creditors, bankruptcy, Chapter 11, restructuring, investor protection, opportunism, shareholder primacy, negotiation
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