Corporate governance and financial contracting: bondholder takeover defenses in poison puts

Abstract

Bondholder governance through the use of bond covenants and the interactions between shareholder and bondholder governance mechanisms has been recently highlighted in the corporate governance literature. In this paper, we study bondholder governance mechanisms through takeover-related bond covenants (i.e., poison puts), confirm with agency theory on the characteristics of firms that are more likely to use these covenants, and emphasize the importance of bondholder governance in the overall structure of corporate governance. We find that poison puts are often bundled with asset sale, payout, and financing restrictions, which is consistent with agency theory. We also find that high growth firms, large, profitable, low-leverage firms are more likely to use poison puts. In addition, our results on free cash flow, insider and institutional ownership provide support for agency explanation. Lastly, we find that poor bond market performance and good equity market performance are likely to motivate the incidence of poison put bond issuance. Volatility of interest rate and volatility of bond index returns motivate more issues of poison put debt. Finally, greater market term and default premiums promote the use of poison puts.