What Does Nasdaq's High-Yield Bond Market Reveal about Bondholder-Stockholder Conflicts?

Abstract

We use data from Nasdaq's FIPS system for reporting transactions in selected highyield corporate bonds to investigate the relationship between the returns on a firm's stock and the returns on its publicly traded, high-yield debt. Regression models and analysis of the behavior of the returns around events associated with agency conflict show that the returns follow complex patterns of similarity and divergence. Positive co-movement is the dominant form of the relationship, but opposite movement of the bond and stock returns around those events indicates agency conflicts between bondholders and stockholders. This study uses previously unavailable data on the prices of high-yield, nonconvertible bonds to explore the correlation of the returns on these debt issues and the returns on the common stocks of the issuing firms. Our purpose is to determine if these two sets of returns provide new evidence on the impact of agency conflicts between stockholders and bondholders. Returns on high-yield issues are particularly useful to our study because they are obligations of highly leveraged firms and are thus likely to indicate complex relationships between the firm's stockholders and bondholders. Furthermore, the pronounced default risk of these issues makes their market values especially sensitive to agency conflicts or transfers of wealth between the two types of investors. Because our study evaluates the relationship between bond and stock returns across individual firms, its findings represent an important complement to the studies of the aggregate or portfoliolevel relationships between the returns of common stocks and high-yield bonds. By looking further into the impact of agency conflict, our study also provides important new information for investors who are interested in certain hedge and arbitrage strategies involving both the stocks and bonds of highly leveraged firms.