Financial innovation and investor wealth: A study of the poison put in convertible bonds

Abstract

The takeover boom of the 1980s was accompanied by a series of innovations in debt contracts, including the poison put that allows bonds to be redeemed in the event of a corporate control change. The poison put was included in a large majority of convertible debt offerings, shortly after the first issues with such provisions. We attempt to understand the factors that contributed to the widespread adoption of this innovation in convertible bonds and the consequences for shareholder wealth. Our findings suggest that by reducing the potential for bondholder-shareholder conflicts and by conveying positive information about future takeover prospects, poison puts result in significant benefits to issuing firm shareholders, particularly if the firm is under takeover speculation. There are, however, no benefits when a firm has adopted antitakeover measures prior to the offering. There is weaker evidence that existing bondholders do worse when poison puts are present.