Wealth transfer effects between stockholders and bondholders

Prior research has addressed the question of whether certain events cause a transfer of wealth between stockholders and bondholders but does not control for the events’ impacts on firms’ credit risk. This may explain why many studies fail to identify wealth transfers. By employing announcements of reductions in credit quality, we find that two types of events cause wealth transfers from bondholders to stockholders. These are unexpected increases in firm leverage, and the firms’ contemporaneous involvement in M&A. Both cases reveal positive excess stock returns and CDS premiums, which exhibit a significantly positive correlation.

► Verifies wealth transfer effects for general events, such as increases in leverage. ► Convincingly verifies (within-firm) wealth transfer for M&A transactions. ► Develops a measure for surprising firm events. ► Analyzes rating announcements by the rating agency's rationale in stock and CDS markets.