Dismantling Bondholder Rights

Abstract

Totaling in excess of $100 billion dollars in transactions annually, debt buybacks allow a company to repurchase bonds from investors, rewriting bargains and stripping away creditor control rights in the process. This Article shows that regulation systematically under-protects bondholders in the context of debt buybacks. It makes three points. First, bondholders confront information asymmetries that enable issuers to buy back creditor claims cheaply. Regulation imposes near negligible requirements on issuers to disclose information about the transaction. Lacking fiduciary protection, bondholder interests are vulnerable to being extinguished by issuers in the interests of promoting those of shareholders and managers. Second, buybacks diminish the power of creditor control rights. Alongside information asymmetries, bondholders confront coordination costs and tight deadlines within which to evaluate the terms of a buyback and changes to bondholder control rights. Owing to these costs, issuers can systematically underprice control rights. Bondholders will not act where the gains of agitation will be less than the cost of information gathering, coordination, and action. By strategically underpricing a buyback by an amount approximating these transaction costs, an issuer can pocket the difference between the price paid for the claim and that which should have been paid to bondholders for their bargain. Third, debt buybacks can allow one set of creditors (notably, banks) to extract value from bondholders. By pushing an issuer to buy back bond claims cheaply, banks (usually with greater individual exposure through loans) can increase their chances of being repaid. They can also acquire a more powerful voice in the issuer’s internal governance by muting that of bondholders. In concluding, this Article offers two proposals to bolster bondholder protection, advocating for greater disclosure and contractual fixes to safeguard the value of claims. These proposals help to preserve the welfare of investors and protect their longer-term confidence in debt capital allocation.