Debt Securities

Chair: Barney Hartman-Glaser, University of California-Los Angeles

A New Theory of Credit Lines (With Evidence)

Jason Roderick Donaldson, Washington University-St. Louis

Naz Koont, Columbia University

Giorgia Piacentino, University of Southern California

Victoria Vanasco, Centre de Recerca en Economia Internacional

Abstract: We develop a model that suggests a heretofore unexplored role of credit lines: To mitigate debt dilution. The results give a new perspective on the literature on leverage ratchet effects, suggesting they can be curbed by (latent) credit lines, and on latent contracts, suggesting collusive outcomes are unlikely to arise in dynamic environments. The model explains numerous facts, includ- ing why credit lines are pervasive but rarely drawn down and why they are bundled with loans, especially for riskier borrowers. We find that the risk of credit line revocation increases borrower leverage and riskiness, suggesting that limited bank commitment can contribute to corporate distress. We find empirical support for this prediction.

Discussant: Peter DeMarzo, Stanford University

Short-Term Debt Overhang

Kostas Koufopoulos,

Giulio Trigilia, University of Rochester

Pavel Zryumov, University of Rochester

Discussant: Anton Tsoy, University of Toronto

Poison Bonds

Rex Wang Renjie, Vrije Universiteit Amsterdam

Shuo Xia, Halle Institute for Economic Research

Abstract: This paper documents the rise of “poison bonds”—corporate bonds that allow bondholders to demand immediate repayment in a change-of-control event. The share of poison bonds among new issues has grown substantially in recent years, from below 20% in the 90s to over 60% since mid-2000s. This increase is predominantly driven by investment-grade issues. We provide strong evidence that the pressure to eliminate poison pills has led firms to issue poison bonds as an alternative. Further analyses suggest that this practice entrenches incumbent managers, coincidentally benefits bondholders, but destroys shareholder value. Holding a portfolio of firms that remove poison pills but promptly issue poison bonds results in negative abnormal returns of -7.3% per year. Our findings have important implications for understanding the agency benefits and costs of debt: (i) more debt does not necessarily discipline the management; and (ii) even without financial distress, managerial entrenchment can lead to conflicts between shareholders and creditors.

Discussant: Shohini Kundu, University of California-Los Angeles