A New Governance Structure for Corporate Bonds

Abstract

This article proposes a new governance structure for publicly issued corporate bonds. Ownership of public bonds is bothfluid and dispersed Fluidity and dispersion generate benefits: They increase the liquidity of public bonds and make their risk more easily diversifiable. By the same token, however, fluidity generates a bonding problem and dispersion generates a collective action problem. In the context of public bonds, these problems increase the agency cost of debt and thus lower the overall value of the company. Private debt, the ownership of which is neither fluid nor dispersed, lacks easy diversification and liquidity, but also entails lower agency cost of debt. The new governance structure Professors Yakov Amihud, Kenneth Garbade, and Marcel Kahan propose is designed to overcome the collective action and bonding problems while retaining the easy diversifiability and liquidity associated with public bonds. The centerpiece of this structure is a new type of bondholder representative, the supertrustee. In contrast to the conventional indenture trustee, the supertrustee will be given the authority and the incentives to monitor the company actively, as well as to enforce and, where appropriate, to renegotiate a bond's covenants on behalf of public bondholders. Because the supertrustee is a single entity, and because the company will have some power over who is appointed as supertrustee, this structure resolves the collective action and bonding problems presently associated with dispersed andfluid ownership of public debt. At the same time, because public bond indentures will contain covenants similar to those presently contained in private debt, agency costs are reduced