Bond Price Reactions Research Articles

Corporate Bondholder Reactions to Bank Loan Covenant Violations and the Evolution of Bank Loan Covenants

This paper examines firms’ corporate bond price reactions to bank loan covenant violations. Using an event study approach, we find that firms’ bond price response is marginally negative in the 1990s and becomes significantly positive in the 2000s. The positive bond price reactions suggest bondholders benefit from bank loan covenant violations in more recent years. Specifically, bank loan covenant violations enable banks to step in and take necessary actions to protect creditors’ interests, which benefit not only private lenders but also public corporate bondholders. In addition, the temporal change in bond price response suggests the disciplining role of bank loan covenants becomes increasingly important in recent years: banks gradually take debt covenants as “trip wires”, which give banks an option to take necessary actions when the early warning signal shows up through covenant violations. Furthermore, we find that bondholders and stockholder reactions are positively correlated in recent years, and that managerial entrenchment could decrease banks’ influence after violations.

Merton model’s prediction and empirical evidence on bond and equity prices reaction to new bond issues

ABSTRACT I use the Merton model as a theoretical framework to assess 1) the expected impact of a new bond offering on existing bond and stock prices, and 2) how the bond and stock price reactions are conditioned on characteristics of the new and existing bonds and the planned use of the new funds. Consistent with the Merton model prediction, I find negative and significant average abnormal returns of issuers’ existing bonds over a three-day event window surrounding the announcement of new bond issues. In contrast, average abnormal stock returns of the issuing firms are positive but insignificant. Bond market announcement returns estimated using daily corporate bond data from TRACE are more negative for longer-term outstanding bonds and less negative when the new bonds are junior to existing bonds. I also find that the bond price reaction (stock price reaction) is more negative (less positive) when funds are to be used for expansion than when they are to be used to repurchase stock.

Equity analysts' recommendation revisions and corporate bond price reactions

This paper analyzes bond price reactions to examine the information spillover from equity analysts' recommendation revisions into the bond market. We document a positive relation between bond price reactions and recommendation revisions. On average, bond prices react positively to recommendation upgrades and negatively to recommendation downgrades. The strongest reactions are observed among speculative-grade bonds. While, on average, bond price movements are in the same direction as analysts' recommendation revisions, these revisions can also lead to bond price reactions in the opposite direction to share price reactions. We find evidence of negative bond return reactions relative to share price reactions among firms that are closer to distress, especially when they have high levels of institutional ownership or discretionary accruals. The negative relative price reaction between shares and bonds indicates that equity analyst recommendations sometimes carry security-specific information.

The Effect of Industry Restructuring on Peer Firms

We study the bond price reaction of a merged firms peers, in order to better understand how the market responds to a restructuring. We argue that a merger announcement may signal the possibility of a merger wave to the industry, and in doing so, increase the conditional probability that peer firms might themselves be acquired in the future. However, while peer firm equity holders expect a direct benefit from a potential acquisition—in the form of a price premium—peer firm bond holders can only expect an indirect benefit—in the form of a risk reduction. Consistent with these hypotheses, we show that price reactions are stronger for firms that have a higher unconditional probability of being acquired ex-ante. In addition, we document that, cross-sectionally, the abnormal returns we observe from peer bondholders are concentrated among firms that have the highest expected risk reduction benefit from a potential acquisition. In order to distinguish a potential reduction in risk as the explicit return driver, we show that abnormal bond returns within firm (between different bond issues) are also concentrated among issues that have the highest expected risk reduction benefit.

Are Bond Ratings Informative? Evidence from Regulatory Regime Changes

The Dodd–Frank Act (Section 939B) enacted in 2010 repealed the exemption of credit rating agencies (CRAs) from Regulation Fair Disclosure. Testing whether CRAs continue to provide new information to the market after the repeal, the authors find that the significant prerepeal stock price responses to rating changes disappear after the regime change. Bond price reactions, however, remain significant. These results are even more significant at the investment–speculative boundary. Evidence suggests that CRAs served as a conduit for transmitting private information before the repeal and that the continued bond price reactions are likely due to regulations favoring higher-rated bonds. TOPICS:Fixed income and structured finance, information providers/credit ratings

When are dividend increases bad for corporate bonds?

AbstractEmploying an event study approach, we examine 5,574 bond return reactions to unexpected quarterly dividend change announcements in the U.S. corporate bond market over the period 2002–2014. On average, bond price reaction is in the same direction as dividend changes, which supports the hypothesis that dividend changes signal future firm performance. However, the price reaction varies significantly in the spectrum of bond's risk. Importantly, we document that some bondholders react negatively to unexpected dividend increases, indicating a wealth transfer effect. Such wealth transfer effect is most likely to occur in very high risk bond approaching maturity issued by firms with a low level of cash and incorporated outside Delaware.

Economic Risk Premia in the Fixed-Income Markets: The Intraday Evidence

We use high-frequency data to precisely estimate bond price reactions to macroeconomic announcements and the associated compensation for macro risks. We find evidence of a single factor summarizing the reaction of bond prices to different announcements. Before the financial crisis, the factor risk premium is substantial, significant, and mainly earned before announcement releases. After the crisis, the stock–bond covariance becomes negative and the preannouncement factor risk premium becomes insignificant. Our empirical results are consistent with information leakages that take place ahead of announcement releases and with the implications of a long-run risks model of bond risk premia.

When does the bond price reaction to earnings announcements predict future stock returns?

In this paper I show that the bond price reaction to earnings announcements has predictive power for post-announcement stock returns and that this predictive ability is driven by the bonds of non-investment grade firms. I find that bonds’ predictive ability is more pronounced in firms that have a lower level of institutional shareholder ownership and whose bonds are more liquid. This paper enhances our understanding of the relation between the stock and bond markets and complements the literature which documents whether, and under what circumstances, various accounting-based measures and financial statement components predict post-announcement stock returns.

The Effect of Industry Restructuring on Peer Firms

I study the bond price reaction of a merged firms peers, in order to better understand how the market responds to a restructuring. I argue that a merger announcement may signal the possibility of a merger wave to the industry, and in doing so, increase the conditional probability that peer firms might themselves be acquired in the future. Consistent with this hypothesis, I show that price reactions are stronger for firms that have a higher unconditional probability of being acquired ex-ante. Furthermore I show that following an initial merger, when the signal about a potentially upcoming wave should be the strongest, the peer bond returns are the highest. In addition, I document that, cross-sectionally, the abnormal returns I observe from peer bondholders are concentrated among firms that have the highest expected coinsurance benefit from a potential acquisition. I show that this is the case for bondholders between firms and within firms.

Corporate Bond Price Reactions to Dividend Changes

Employing an event study approach, we examine 5,574 bond return reactions to unexpected quarterly dividend change announcements in the U.S. corporate bond market over the period 2002–2014. Overall, we report a significant bond price reaction in the same direction as dividend changes, which supports the hypothesis that dividend changes signal future firm performance. We also find that the bond return reaction is more pronounced if the dividends are reduced than if they are increased. We document a wealth transfer effect when riskier bonds are issued by firms with a low cash ratio and are approaching maturity. These results still hold after we control for the financial crisis and dividend covenants and when we use alternative variables to capture the dividend surprise.

The information value of credit rating withdrawals

Moody's (2011) withdraws credit ratings when a debt issuer files for bankruptcy, does not provide sufficient information to the rating agency, or is merged with another firm. When ratings are withdrawn, there is less information available regarding an issuer's credit quality. We examine the stock and bond price reactions following announcements of Moody's credit rating withdrawals and find that the announcements of rating withdrawals result in significant and negative stock and bond price reactions for issuers with withdrawn ratings. Issuers that continue to have an S&P or Fitch's rating following a Moody's rating withdrawal experience a smaller stock price decrease than those without credit ratings from any rating agency. Moreover, we find that liquidity risk increases significantly around rating withdrawal announcements because we observe a sharp decrease in bond trading volume and frequency.

Foreign ownership and the credibility of national rating agencies: Evidence from Korea

By analyzing bond price reactions to rating changes in Korea, this study adds a new angle to the existing literature on Global Rating Agencies (GRAs, i.e. Moody’s, S&P’s, Fitch) with higher reputation/independence vs. National Rating Agencies (NRAs) with more in-depth local knowledge. Faced with substantial regulatory burdens, GRAs have chosen to operate indirectly in the Korean domestic market by acquiring local NRAs. In our event study, cumulative abnormal returns following downgrades by a wholly domestically owned NRA tend to dominate those from downgrades by two affiliates of GRAs. This casts doubt on the additional information value of reputation capital acquired through GRA ownership as perceived by emerging markets.

Post-Earnings Announcement Bond Price Reaction

This study examines the bond pricing behaviour over a 30-day interval subsequent to earnings announcements in the sample period of 2002 – 2010. Our results report a significant and positive relation between bond returns and earnings surprises over the 30-day post-earnings announcement period. In addition, we find that this post-earnings announcement drift is mainly driven by negative earnings news. Bond prices do not exhibit a significant response to positive earnings news. This evidence is consistent with the bond asymmetric payoff function according to Black and Scholes (1973). Furthermore, we examine the impact of bond riskiness on bond price reaction to earnings announcements. We find evidence of a stronger reaction from riskier (speculative-grade) bonds to earnings announcements over the 60-day interval.

Post-Earnings Announcement Bond Price Reactions

Post-Earnings Announcement Bond Price Reactions

Stockholder and Bondholder Wealth Effects of CEO Incentive Grants

We examine stock and bond price reactions to CEOs’ first stock option and/or restricted stock grants that appear on ExecuComp. We find positive stock price and negative bond price reactions. Changes in CEO pay‐performance (delta) and stock volatility (vega) sensitivities relate to the reactions. Stock reactions decrease with the change in delta and increase with the change in vega. Bond reactions are the opposite and depend on the CEO's prior equity ownership. Stockholder and bondholder wealth effects are negatively correlated for grants that cause a large change in the vega of CEO wealth, consistent with aggravated risk‐shifting incentives.

The Effect of Seniority and Security Covenants on Bond Price Reactions to Credit News

We examine the daily abnormal returns of corporate bonds with different seniority and security covenants following Moody`s Watchlist and rating change events. We find that bond returns react significantly positive (negative) following upgrade (downgrade) Watchlist events but not necessarily following rating change events. Because Watchlist news precede rating changes, we infer that the Watchlist contains more unexpected information and, hence, the short-run bond price effects are stronger. Especially, we find that subordinated bond prices react more than secured bonds to Watchlist news. However, this finding does not hold when we compare investment and non-investment grade bonds, suggesting that seniority/security can explain the cross sectional bond returns. Our regression results confirm this finding even after controlling for issue- and issuer-specific characteristics such as time to maturity, coupon rate, bond rating, and firm size.

Stockholder and Bondholder Wealth Effects of CEO Incentive Grants

We examine stock and bond price reactions to first time grants of equity compensation to CEOs. For firms granting options and/or restricted stock to their CEOs for the first time during the period 1992 to 2004, we find large positive stock price reactions and large negative bond price reactions. The negative bondholder reactions are significantly larger when the CEO has little or no prior equity ownership and significantly smaller for firms with weak shareholder rights (greater managerial power). We establish links between the stock and bond price reactions and the incentive characteristics of the grants. We find that stock price reactions decrease in CEO pay-performance sensitivity (delta) and increase in the sensitivity of CEO wealth to stock volatility (vega). In contrast, we find that bondholder reactions increase in delta and decrease in vega when the CEO has little or no equity ownership prior to the grant.

Event study concerning international bond price effects of credit rating actions

AbstractThe influence of credit ratings on eurobond prices has been neglected for a long time. It is questionable whether non‐US investors relate their investment decisions on US ratings and whether ratings from US agencies are relevant information sources for international capital markets. This paper examines daily excess eurobond returns associated with announcements of watchlistings and rating changes by Standard & Poor's and Moody's. Significant bond price reactions are observed for announcements of downgradings and negative watchlistings while upgradings and positive watchlistings do not cause announcement effects. Distinct from the results on national capital markets the international evidence shows that besides actual yield level and issuer type the issuer nationality is a key factor that determines the intensity of price reactions after downgrades. The price reaction is also significantly stronger for downgrades into speculative grade. This indicates, that the announcement effects can in part be explained by price pressure effects due to regulatory constraints rather than original information content of rating changes. Copyright © 2001 John Wiley & Sons, Ltd.

The Effect of Dividend Changes on Stock and Bond Prices

ABSTRACTThis study examines stock and bond price reactions to dividend changes. The positive stock market response to dividend increases has several potential explanations, two of the more commonly discussed being information content and wealth redistribution between stockholders and bondholders. The evidence presented supports the wealth redistribution hypothesis but does not rule out the information content hypothesis. Typically we find that the bond price reaction to announcements of large dividend changes is opposite to the stock price reaction. Our results differ from those of Handjinicolaou and Kalay.

The Effect of Dividend Changes on Stock and Bond Prices

This study examines stock and bond price reactions to dividend changes. The positive stock market response to dividend increases has several potential explanations, two of the more commonly discussed being information content and wealth redistribution between stockholders and bondholders. The evidence presented supports the wealth redistribution hypothesis but does not rule out the information content hypothesis. Typically we find that the bond price reaction to announcements of large dividend changes is opposite to the stock price reaction. Our results differ from those of Handjinicolaou and Kalay.