My Research
Working Papers
Covenants
can be viewed as governance mechanism that gives control protection to
debtholders. We construct a Covenant Protection Index for a large sample of
public bonds and investigate:(1) the impact of covenant protection on the
credit spread dynamics; (2) the role of covenant protection in mitigating
managerial risk-shifting. We first document that credit spreads are decreasing
in the strength of covenant protection. The credit spreads of bonds with
minimum and maximum protection can differ by 141 basis points. We conduct novel
analysis including a matching technique and other tests to address the issue of
endogeneity. Secondly, we study the ex post effectiveness of covenant
protection during industry-level and economy-wide negative shocks. Under the
exogenous shocks, bonds with strong protection experience significantly less or
no value loss. Finally, we document that higher CEO risk-taking incentive
(measured by Vega) is associated with higher
credit spreads for bonds with weak protection. For bonds with strong protection,
higher Vega is associated with lower
credit spreads.
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“The
Impact of Shareholder Governance
on Bondholders”, with K.J. Martijn Cremers, Yale
While strong governance can benefit bondholders, different governance mechanisms affect bondholders differently. There can also be important sources of conflict due to strong shareholder control. This paper investigates the effect of strong shareholder control and takeover vulnerability on bond yields, ratings and returns. We document that strong shareholder control can either increase or decrease bondholder risk, contingent on the takeover defenses that the firm has in place. Using the presence of an institutional blockholder to proxy for shareholder control, we find that shareholder control is associated with lower (higher) yields if the firm is protected (exposed) from takeovers. In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 66 basis points. We also find that bond ratings overreact to the appearance of a blockholder but underreact to the interaction between shareholder control and takeover vulnerability. Further, suggestive of risk differences due to governance, we find that a bond portfolio that buys issues of firms with both strong shareholder control and high takeover vulnerability and shorts issues of firms without either shareholder control or takeover vulnerability generates an annual return of 1.5%. Finally, to investigate the importance of the takeover channel, we show that the increase in risk associated with shareholder governance is strongest for issues without event risk covenants that provide protection from takeovers. Therefore, in the absence of event risk covenants, shareholder governance and bondholder interests diverge.
Ongoing Projects
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“Restatement, Incentives and Asset Value Uncertainty – Implications for
Corporate Bond Pricing and Corporate Governance Design”
with
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“Liquidity,
Covenants and Credit Spreads”
with Yang Lu and
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“Financial Contracting and Market Efficiency – A Study of Loan Market
Performance and Subsequent Corporate Bond Rating Changes ”
with Yang Lu,
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“Creditor Protection, Default Risk and Recovery Rate”