Corporate Motives in Repurchases of Discounted Bonds

Abstract

While corporate' repurchases of a firm's own outstanding common shares have received much attention in recent years, repurchases of outstanding discounted long-term bonds has gone relatively unnoticed. A recent paper [7], however, indicates that the volume of bond repurchase activity could be considerable. Under certain circumstances the advantages to the firm of repurchases are indisputable. In most cases, the sinking fund requirement on an outstanding corporate bond issue is satisfied by presenting to the trustee bonds with an aggregate par value equal to the current sinking fund obligation. By using open market purchases of their own discounted bonds, firms usually can obtain substantial cash savings when meeting their sinking fund obligations. Available evidence, however, shows that cumulative repurchases are frequently in substantial excess of sinking fund requirements [7]. Bond repurchases lower the amount of debt financing used in the firm's capital structure. The evidence, however, does not indicate that capital structure adjustments play a role in motivating repurchases [7]. Since the firms are replacing discounted bonds with new debt financing, the purpose must be something other than rearrangement of the capital structure; the objective of this paper is to analyze possible reasons for these corporate repurchases. It is assumed that declines in bo d prices are purely mechanical adjustments of the marketplace. Other factors which could affect bond prices are not pertinent to our objectives and will not be considered.