The Price Effects of Event-Risk Protection: The Results from a Natural Experiment

Authors


  • A portion of the work on this article was completed while David Pedersen was at LeBow College of Business, Drexel University. A portion of the work on this article was completed while Natalie Pedersen was at Drexel University's Earle Mack School of Law. We thank Bill Bratton, Ralph Walkling, and the participants at the 2010 Conference on Empirical Legal Studies, especially Annette Poulsen, for their helpful comments. We also benefited greatly from the comments of three anonymous referees. Any remaining errors are our own.

Karl Okamoto, Director of the Program in Business and Entrepreneurship Law and Professor of Law at the Earle Mack School of Law, Drexel University, 3320 Market St., Ste. 416, Philadelphia, PA 19104; email: Karl.okamoto@drexel.edu. David Pedersen is Assistant Professor of Finance at West Chester University; Natalie Pedersen is Assistant Professor of Legal Studies at the LeBow College of Business, Drexel University.

Abstract

Prior studies conclude that bond prices reflect both an issuer's event risk and a bond's contractual protections from event risk. Therefore, it is assumed that the market requires a higher return for unprotected bonds than for comparable protected bonds. These prior studies, however, struggle with the problem of isolating the pricing effect by controlling for comparability. Issuers will differ from each other on a number of other attributes that could affect their bond prices. The issue of comparability eludes a simple modeling solution given the indefiniteness and multiplicity of variables that could cause the market to distinguish one issuer from another. Recent court decisions regarding the buyout of Bell Canada Enterprises provide a natural experiment for evaluating the pricing effect of event-risk protection that mitigates this comparability problem. Based on this experiment, we find support for the prior conclusions that an exogenous shift in event-risk protection is priced by the market.

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