An empirical investigation of corporate bond clawbacks (IPOCs): Debt renegotiation versus exercising the clawback option (original) (raw)
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SSRN Electronic Journal, 2000
Clawback provisions allow the issuer to partially redeem a bond issue often within three years of issuance using proceeds only from new equity issues. Empirical evidence indicates the clawback provision is rarely exercised. This poses an interesting dilemma as clawback provisions are an expensive source of funding, often commanding yields that are significantly higher than traditional corporate bonds. We develop a simple model that provides a rationale for the scarcity of call redemptions and the higher yields of clawback bonds. The model predicts a relation between issuance of clawback bonds, cash flow volatility and the probability of renegotiation of clawback debt contracts.
Existing empirical work supports the notion that make whole and claw back bonds are explained as methods to resolve the underinvestment problem. We suggest that if these provisions genuinely resolve the underinvestment problem then make whole and claw back provision bonds should share in the benefits from the resolution of the underinvestment problem through more frequent credit upgrades and/or less frequent credit downgrade when compared to a similar sample of otherwise similar callable bonds not employing make whole or claw back provisions. We find evidence that make whole call provisions genuinely alleviates the underinvestment problem but the claw back provision seems to resolve the underinvestment problem at the expense of bondholder’s wealth.
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Bondholders have failed to respond to corporate restructurings by demanding more protective provisions; in fact, the trend has been toward fewer rather than more restrictive covenants. In this article, we model the use of contractual covenants as a trade-off between contract implementation costs and deadweight efficiency losses. We find that the current lack of restrictive covenants is arguably consistent with rational investor behavior. The key to this conclusion is the recognition that there is an implicit ex-post settlement component to debt contracts, which is enforced by the courts. A look at the behavior of the courts and of bondholders supports our point of view.
Corporate risk-taking after adoption of compensation clawback provisions
Review of Quantitative Finance and Accounting, 2019
The adoption of clawbacks purports to mitigate harmful behavior to firms' operation, including excessive corporate risk-taking at the expense of investors' interests and firms' long-term benefits. This study empirically examines whether corporate risk-taking declines after the adoption of clawback provisions in the compensation contracts of top executives in publicly traded US firms. Using a sample of clawback adopters and non-adopters in the Russell 3000 Index firms during the period 2005-2014, we find that the presence of clawback provisions is significantly associated with a lower level of corporate risk-taking as reflected by firms' investment strategies and their capital structure. Additional analyses suggest that this association is stronger for small firms and for firms audited by Big 4 auditors. Robustness checks of using alternative measures for corporate risk-taking, controlling for the occurrence of financial restatements, board independence, and internal control quality, and employing a propensity matching score matching sample further support the main results. Overall, the results of this study indicate more conservative corporate risk-taking behavior after the adoption of clawbacks.
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This paper examines a recent sample of public workouts for distressed high-yield debt. The nature of holdouts and the effectiveness of coercive tactics in alleviating the holdout problem is analyzed. Tender offers are in relatively less financial distress, exhibit more severe holdouts, and are more coercive than exchange offers. Tender offers also have higher completion rates and fewer Chapter 11 filings. Security prices react positively to announcements of tender offers, negatively to exchange offers. Evidence suggests that coercion is not detrimental to bondholders, and may benefit security holders by increasing the likelihood of a less costly, out-of-court restructuring.
Debt Valuation, Renegotiation, and Optimal Dividend Policy
Review of Financial Studies, 2000
The valuation of debt and equity, reorganization boundaries, and firm's optimal dividend policies are studied in a framework where we model strategic interactions between debt holders and equity holders in a game-theoretic setting which can accommodate varying bargaining powers to the two claimants. Two formulations of reorganization are presented: debt-equity swaps and strategic debt service resulting from negotiated debt service reductions. We study the effects of bond covenants on payout policies and distinguish liquidity-induced defaults from strategic defaults. We derive optimal equity issuance and payout policies. The debt capacity of the firm and the optimal capital structure are characterized.
Firm-Level Heterogeneity of Clawback Provisions
Academy of Management Proceedings, 2014
We investigate the degree to which implementing a clawback policy, a special part of the executive's compensation contract, is an adequate governance mechanism to deter executives from misbehavior and to recover excess-pay. By focusing on the firm-level heterogeneity in the structure of clawbacks, we recognize that firms have considerable discretion in how they design their policies. We find that firms make heavily use of their discretion in adopting more or less deterrent policies and that most firms have weak clawback provisions. We analyze voluntary adopted clawbacks of all Russell 3,000 non-financial firms over 2007-2012. We conduct an extensive linguistic and a factor analysis to construct a deterrent index for 3,578 clawback observations. This index reflects the degree to which the contractual form of each clawback contains the core elements of a deterrent clawback policy. Our results, which also take into account the self-selection problem of voluntarily adopting a clawback, show that executive power, the executives' pay level, and weak corporate governance are associated with a low deterrent level. We also find that the deterrent level increases in directors' experience, corporate profitability and management ownership.
Journal of Corporate Finance, 2003
We evaluate the costs and benefits of restrictive covenants in bonds issued in 1989 and 1996. Our results indicate that firms with growth opportunities are more likely to seek to preserve flexibility in future financing activities by not including dividend or debt issuance restrictions in their bond contracts. We do not find, however, that the use of other restrictive covenants is significantly lower for firms with high investment opportunities. Instead, the use of these other covenants is primarily driven by the issuing firm's likelihood of financial distress. Our results emphasize that contractual relations between firms and bondholders reflect the specific needs of the contracting parties. D
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SSRN Electronic Journal, 2021
We examine the long-run performance of over 16,000 debt renegotiations. We find that, compared with non-renegotiating firms matched on size, book-to-market, profitability, and investment, renegotiating firms, on average, deliver 10.5 (18.5) percent higher stock returns over the three (five) years following the renegotiation. This renegotiation effect is strongest for waivers and for amendments to loan interest rates and financial covenants. Renegotiations lead to immediate increases in capital expenditures and working capital, but lagged improvements in earnings and cash flow from operations. Renegotiations followed by larger improvements in accounting fundamentals offer better long-run stock performance.