The Broken Bond Market

59 Pages Posted: 14 Oct 2021 Last revised: 26 Feb 2022

See all articles by Jonathan Brogaard

Jonathan Brogaard

University of Utah - David Eccles School of Business

Yesha Yadav

Vanderbilt University - Law School

Date Written: October 13, 2021

Abstract


Valued at around $10 trillion, the U.S. corporate bond market is slow, expensive, and inefficient. This Article argues that the bond market – premised on contract – rests on a flawed regulatory design that delivers neither investor protection nor market quality. It makes three contributions. First, it shows that bondholders navigate a conflict between protecting themselves using a tailored contact – and being able to easily trade their bond. By tailoring a contract to match the riskiness of an issuer, bondholders end up holding a less standard claim that becomes harder and costlier to trade. Second, the Article develops the implications of this conflict for investor protection. Bondholders incur transaction costs that do not exist in equity markets. Activism is more difficult as investors cannot deploy the threat of exit cheaply to pressure managers. Monitoring costs are high as prices are incapable of performing a surveillance function. This Article thus refines the traditional notion of bondholders being passive, apathetic actors. Rather, the impossibility of achieving both investor protection and tradability limits bondholders in their ability to push back against managerial and shareholder misbehavior. Third, this Article sets out a three-part solution designed to create choice, control, and tradability. It proposes: (i) standardization through the creation of tiers of form contracts that enhance tradability while offering some tailorability in the choice of model contract; (ii) a stronger role for trading platforms in monitoring and enforcing contract terms; and (iii) maintaining a bespoke segment, offering maximum flexibility to contract, to accommodate those that want fullest tailorabilty even at a cost to tradability. Taken together, this solution aims to repair the broken bond market and to promote investor protection, trading, and efficiency as fundamental features of securities market design.

Keywords: Corporate Bonds, Credit Market, Equity, Securities, Investors, Bondholders, Indenture, Trustees, Banking, Liquidity, OTC markets, Dealers, Primary Dealers, Market Efficiency, Contracting, Trading Platforms, Exchanges

Suggested Citation

Brogaard, Jonathan and Yadav, Yesha, The Broken Bond Market (October 13, 2021). Vanderbilt Law Research Paper No. 21-43, Available at SSRN: https://ssrn.com/abstract=3941941

Jonathan Brogaard (Contact Author)

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

HOME PAGE: http://www.jonathanbrogaard.com

Yesha Yadav

Vanderbilt University - Law School ( email )

131 21st Avenue South
Nashville, TN 37203-1181
United States

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