This paper compares the terms of 63 privately-placed debt agreements with those found in public bond indentures. The main results of the analysis are as follows: 1) Private agreements more aggressively control the actions of equity holders by setting various covenants more tightly, by contrasting on quantities that are volatile and not under the direct control of managers, and by using relatively vague terminology. This finding does not rely on credit quality differences between the public and private debt markets. Furthermore, covenant differences between investment grade and junk issues are less pronounced in the private market than in the public market. 2) Private agreements provide lenders with the means to monitor borrowers more carefully. 3) Private agreements attempt to control intra-claim conflicts, i.e. those arising between holders of the same bond issue. 4) Private agreements payment terms are tailored to suit lenders by avoiding embedded interest rate options.

It is widely believed that it is optimal to call a bond as soon as its market price equals its call price. We show that this policy is generally not optimal when there is more than one bond issue outstanding because minimizing the value of a particular bond issue is not the same as maximizing the value of equity. Furthermore, the value of a callable bond can rationally exceed the call price when a firm follows the optimal call policy. These results have important implications for valuing and hedging callable bonds.

This paper documents that firms can and do change the convenants of their public debt indentures through consent solicitations. A game theoretic model of these solicitations shows that they can coercive, i.e. bondholders who cannot coordinate their actions may consent to convenant changes even when it is not in their collective interest to do so. Despite this theoretical finding, abnomral bondholder returns around the announcements of consent solicitations are significantly positive. Further analysis of the data indicates that bondholders can, in fact, coordinate their actions to modify or defeat disadvantageous proposals. As a result, bondholders obtain a portion of the gains resulting from convenant modifications. The public policy implication of these findings is that bondholders do not need additional regulatory or judicial protection in the solicitation process.

This paper constructs a dynamic model of the equilibrium determination of relative prices when arbitragers face holding costs. The major findings are that 1) models based on riskless arbitrage arguments alone may not provide usefully tight bounds on observed prices, 2) arbitragers are often most effective in eliminating the mispricings of shorter-term assets, 3) arbitrage activity increases the mean reversion of changes in the mispricing process and reduces their conditional volatility, and 4) there may be “spillovers” in arbitrage activity, i.e. profits per arbitrager in a given market may increase with the number of arbitragers. Finally, several predictions of the model are consistent with the growing empirical literature on deviations of prices from fundamental values.