Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)
The Defeasance of Control Rights
(), Antoine Faure-Grimaud
() and Zsuzsanna Fluck
Abstract: We analyze one frequently used clause in public bonds
called covenant defeasance. Covenant 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 to be paid out on schedule.
Bond covenants are predominantly noncontingent, action-limiting covenants.
By giving the issuer an option to remove covenants, noncontingent control
rights can be made state-contingent even when no interim signals are
available. We provide a theoretical justi cation for covenant defeasance
and show empirically that such a clause allows for the inclusion of more
covenants in public bond issues. In line with the model's prediction, our
empirical analysis documents a 13-25 basis points premium for defeasible
bonds. This premium amounts to an annual saving of about $1m per year, or
$11m over the lifetime of an average bond.
Keywords: Bonds; Covenants; Defeasance; Renegotiation; (follow links to similar papers)
JEL-Codes: D86; G12; G32; (follow links to similar papers)
46 pages, January 28, 2011
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