Adjustment Bond – Definition

Cite this article as:"Adjustment Bond – Definition," in The Business Professor, updated September 20, 2019, last accessed August 3, 2020, https://thebusinessprofessor.com/lesson/adjustment-bond-definition/.

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Adjustment Bond Definition

Corporations issue adjustment bonds when it recapitalizes its debts during financial difficulties and bankruptcy proceedings. These bonds are issued against the outstanding bonds to the existing bondholders. When a corporation meets with bankruptcy and is unable to make payments on its previous bonds, it issues adjustment bonds with the permission of the bondholders.

A Little More on What is an Adjustment Bond

Adjustment bonds help a company avoid bankruptcy. Against such bonds, interest is paid only when the business has earnings. In this way, the company does not have to face a default for unmade payments. The company adjusts the terms of its bonds in terms of interest rates and dates of maturity. Thus, the company gets a better chance to meet its obligation without facing bankruptcy.

The bondholders approve the issuance of adjustment bonds because exchanging the existing bonds with adjustment bonds are often better for them than the other alternative which is bankruptcy. It is beneficial for them in the long term, as an adjustment bond would allow them to earn more than the earning from the company’s liquidation.

During the Chapter 11 bankruptcy proceeding, all the assets of the company are liquidated to pay back its creditors. However, this liquidation often pays only a fraction of what the company owes to its creditor. Adjustment bonds provide an opportunity for the company to restructure its debts and continue its operations. In this way, the bondholders stand a better chance to get their dues in the long term.

While a company faces financial difficulties, the company representatives meet the creditors that include it, bondholders, to find an alternative arrangement that is beneficial for both the company and its creditors. In these meetings, they negotiate the terms to make it a better alternative than bankruptcy.

Usually, the provisions of adjustment bonds allow the company to pay interests only when it has a positive earning. It depends on the specific terms of the adjustment bond whether the bondholders will get the missed interest payment in full, in parts or nothing at all. It also helps the company to avoid default on its debt as they do not have to pay any interest in case of negative earning. Any interest paid against adjustment bonds is a tax-deductible expense.

However, often the creditors are required to wait for a long time to be repaid against an adjustment bond. The company needs to recover from its financial difficulties before it can pay its creditor.

Reference for “Adjustment bonds”

https://www.investopedia.com › Investing › Bonds / Fixed Income

www.businessdictionary.com/definition/adjustment-bond.html

https://www.money-zine.com/definitions/investing-dictionary/adjustment-bond/

https://financial-dictionary.thefreedictionary.com/adjustment+bond

www.investorwords.com/6972/adjustment_bond.html

https://definitions.uslegal.com/a/adjustment-bond/

Academics research on “Adjustment bonds”

Dynamic investment models and the firm’s financial policy, Bond, S., & Meghir, C. (1994). Dynamic investment models and the firm’s financial policy. The Review of Economic Studies, 61(2), 197-222. In this paper we investigate the sensitivity of investment to the availability of internal funds using the hierarchy of finance approach to corporate finance. We characterize the empirical implications of this approach for dynamic investment models and test these implications using firm-level data. The model we estimate is based on the Euler equation for optimal capital accumulation in the presence of convex adjustment costs. The theoretical model explicitly allows for debt finance and financial assets. The empirical investigation uses U.K. company panel data to estimate dynamic investment models using GMM and tests the derived implications.

GROWN STRUCTURAL ADJUSTMENT, Barchiesi, F. (2000). GROWN STRUCTURAL ADJUSTMENT. A Thousand Flowers: Social Struggles Against Structural Adjustment in African Universities, 165.

Balance of payments crises and fiscal adjustment measures, Frenkel, M., & Klein, M. (1991). Balance of payments crises and fiscal adjustment measures. Journal of Macroeconomics, 13(4), 657-673. A model with optimizing firms and consumers is used to explore the effects of unannounced and preannounced fiscal adjustment policies that are intended to prevent an impending balance of payments crisis. It is shown that preannouncement unambiguously raises the required fiscal adjustment effort so that, from the government’s point of view, “cold turkey” is the preferable policy. The effect of preannouncement on the private sector’s adjustment cost is ambiguous since preannouncement induces an externality which may either benefit or harm the private sector, depending on the nature of the measure that is preannounced.

What Do Credit Markets Tell Us About the Speed of Leverage Adjustment?, Elkamhi, R., Pungaliya, R. S., & Vijh, A. M. (2014). What Do Credit Markets Tell Us About the Speed of Leverage Adjustment?. Management Science, 60(9), 2269-2290. This paper proposes a new methodology to infer investors’ expectations about the speed of leverage adjustment implicit in the prices of credit instruments. On average, the credit markets imply a fairly rapid annual speed of adjustment of 26% toward a firm’s predicted leverage. The speed varies considerably across partitions formed by the differential implications of the pecking order, market timing, and trade-off theories of capital structure. This finding suggests that investors’ expectations are formed in accordance with all three theories. We also show that the addition of firm fixed effects in the predicted leverage model gives noisier estimates of investors’ expectations of future leverage, and that a firm’s initial leverage is a poor estimate of its future leverage.

A Treasury Income Bond, Scott, R. H. (1959). A Treasury Income Bond. National Tax Journal, 12(4), 363-366.

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