The wealth effects of merger and acquisition announcements on bondholders: New evidence from the over-the-counter market

The coinsurance and wealth transfer hypotheses are both used to explain the wealth effect of acquirer and target bondholders during mergers and acquisitions (M&As). Hindered by a paucity of high-quality bond data, to date there is at best only limited and mixed evidence. Using bond transaction data from TRACE, we investigate daily bond market reactions to M&A announcements. Consistent with the wealth transfer hypothesis, we find new evidence that acquiring (target) firm bondholders experience negative (positive) and statistically significant abnormal returns. Moreover, investors of speculative-grade bonds experience more negative (positive) returns for the acquirer (target) than investment grades. In addition, larger deals and cash payment method worsen acquirer bondholders' losses and reduce target bondholders' gains. Target (acquirer) bonds experience more positive (negative) returns when the acquirer (target) is a public firm and when the target's credit rating is below the acquirer's. Lastly, consistent with a loss (gain) to acquiring (target) firm bondholders in the initial market reactions, acquirer (target) bonds are more likely to have their credit rating downgraded (upgraded) following the announcement of a merger or acquisition.