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The Defeasance of Control Rights
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We analyze one frequently used clause in public bonds called "covenant defeasance". Defeasance allows the bond issuer to remove all of the bond's covenants by placing the remaining outstanding payments with a trustee in an escrow account. Bond covenants are predominantly negative (non-contingent) covenants. By giving the firm an option to remove covenants, non-contingent control rights can be made state-contingent even when no interim signals are available. Apart from providing a theoretical justification for defeasance we show empirically that defeasance allows for the inclusion of more covenants in bond issues. Also, investors are willing to pay a premium of 20 to 88 basis points for defeasable bonds.
Title: The Defeasance of Control Rights
Description:
We analyze one frequently used clause in public bonds called "covenant defeasance".
Defeasance allows the bond issuer to remove all of the bond's covenants by placing the remaining outstanding payments with a trustee in an escrow account.
Bond covenants are predominantly negative (non-contingent) covenants.
By giving the firm an option to remove covenants, non-contingent control rights can be made state-contingent even when no interim signals are available.
Apart from providing a theoretical justification for defeasance we show empirically that defeasance allows for the inclusion of more covenants in bond issues.
Also, investors are willing to pay a premium of 20 to 88 basis points for defeasable bonds.
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