Debt Buybacks and the Myth of Creditor Power
66 Pages Posted: 22 Oct 2019 Last revised: 21 Nov 2019
Date Written: October 21, 2019
This Article argues that regulation fails to protect bondholders in the context of a debt buyback – when an issuer repurchases its debt with a view to extinguishing the claim. Scholars have developed an expansive body of research examining share buybacks and debated 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 redefining issuer-bondholder relations and corporate capital structure.
To show how regulation systematically under-protects creditors, this Article 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 also become vulnerable to being short-changed by issuers in the interests of securing gains for shareholders and managers. Second, buybacks diminish the power of creditor control rights, recently enjoying prominence owing to the emergence of bondholder activists. Alongside limited disclosure, bondholders confront coordination challenges and tight deadlines within which to evaluate a buyback. This difficulty gives issuers scope to underprice creditor controls. Bondholders will not agitate 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, banks (usually with greater individual exposure through their loans) can increase their chances of being repaid. They can also acquire a more powerful voice for themselves in the borrower’s internal governance by muting that of bondholder activists. In concluding, this Article offers proposals to bolster bondholder protection, advocating for greater disclosure and a discrete fiduciary duty to be imposed on managers in the context of debt buybacks. These steps help to more fully realize the goals of investor welfare 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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