Market Timing and Wealth Transfer in Debt Repurchases: The Decision between Tender Offers and Open Market Bond Repurchases

Abstract

This study investigates how the firm’s objective of the bond repurchase affects its choice of whether to repurchase on the open market or via a tender offer. Unlike tender offers, open market repurchases are not pre-announced and the identity of the buyer is unknown to the seller. We provide evidence that firms are likely to repurchase on the open market when they seek to exploit mispricing of their bonds and when they seek to manage their financial reports, either in order to meet earnings targets or avert debt covenant violations. When firms seek to amend indenture terms they are likely to choose a tender offer over an open market repurchase. We also find that mispricing exploitation is mitigated when the information quality available to bondholders is higher and that insiders take advantage of the likely wealth transfer from bondholders to shareholders achieved in open market repurchases.