Junk Bonds, Bank Debt, and Financing Corporate Growth
43 Pages Posted: 20 Feb 1998
Date Written: October 1997
Junk bonds have been portrayed as an important alternative source of debt finance for high-growth firms that rely extensively on bank debt. We investigate the role of junk bonds in corporate finance, using a sample of firms that issued junk bonds to pay down bank loans. Bank debt paydowns are the most frequent reason firms issue junk bonds. Sample firms are extremely fast growing, and the junk bond issues typically follow operating earnings declines. Our tests indicate that the looser contractual restrictions in junk bonds enable the firms to maintain financial flexibility, defined as a capital structure's ability to support activities at low transaction and opportunity cost. Alternative explanations for the bond issues have no support. For example, we find no evidence that managers reduced their reliance on bank debt to avoid monitoring by banks. Sample firms obtained most of their bank debt through revolvers, which can also provide flexibility, and firms typically reborrowed from banks to finance continued high growth.
See also the related papers "Information Effects of Spin-offs, Equity Carve-outs, and Targeted Stock Offerings" by Stuart Gilson, Paul Healy, Christopher Noe, and Krishna Palepu; and "Valuation of Bankrupt Firms" by Stuart Gilson, Edith Hotchkiss, and Richard Ruback
JEL Classification: G32
Suggested Citation: Suggested Citation