Is The Put Option In U.S. Structured Bonds Good News For Both Bondholders And Stockholders?

The recent financial crisis has brought into spotlight various financially engineered products, their design parameters, and the impact of these design parameters on the bondholders and the common stockholders. We analyze the common stock performance of 134 firms issuing the callable-puttable bonds, a structured derivative security, issued between 1977 and 2005. We focus our study on the common stock performance of the issuing firms around the issue date and the put date. We use the Fama French (1993) four factor regression model to estimate the common stock performance of the issuing firms two years before and after the issue and the put date. We find that these firms underperform the market throughout. The firms perform worse after the issue date but improve their performance as we get closer to the put date. We find strong evidence that the presence of the put option in these securities provides protection to the bondholders as well as improved returns to the common stockholders. The deferred put option can mitigate the agency1 problem between the stockholders and the bondholders. © EuroJournals Publishing, Inc. 2010