| Impact of various equity governance mechanisms and the central debt governance mechanism - covenants, on bondholders are investigated in this dissertation. First, the impact of shareholder control (proxied by the existence of institutional blockholders) on credit risk depends on takeover vulnerability. Shareholder control is associated with higher (lower) yields if the firm is exposed to (protected from) takeovers. However, event risk covenants reduce the credit risk associated with strong shareholder governance. Second, we construct a Covenant Protection Index for a large sample of public bonds in U.S. and investigate: (1) the impact of covenant protection on the credit spread dynamics; (2) the role of covenant protection in mitigating managerial risk-shifting. We first document that, ex ante, credit spreads are decreasing in the strength of covenant protection. Furthermore, ex post, an investment strategy of buying bonds with strong protection and shorting bonds with weak protection generates an abnormal return of 2.71% per year which is statistically significant. We conduct novel analysis including a matching technique and other tests to address the issue of endogeneity. To further show the pricing impact is justified, we study the ex post effectiveness of covenant protection during industry-level and economy-wide negative shocks. Under the exogenous shocks, bonds with strong protection experience significantly less or no value loss. Finally, we document that higher CEO risk-taking incentive (measured by Vega) is associated with higher credit spreads for bonds with weak protection. For bonds with strong protection, higher Vega is associated with lower credit spreads. |
