The Impact of In-substance Defeasance on Bondholder and Shareholder Wealth.

This paper hypothesizes and tests the argument that a defeasance transaction initiates a wealth transfer from stockholders to bondholders. The authors empirical tests provide compelling evidence of bondholder gains, but no support for shareholder losses when a firm defeases debt. They speculate that the insignificance of the loss to shareholders is primarily due to the size disparity between the value of defeased debt and the market value of outstanding equity, since the suggested economic merits of defeasance appear unfounded. Although they cannot prove an agency motivation for defeasance, they find a very high correlation between compensation tied to earnings and defeasing debt at book gain. Copyright 1989 by American Finance Association.