Defeasance of control rights

We analyze one frequent clause in bonds, covenant defeasance. Covenant defeasance allows the issuer to remove the bond's covenants by placing the remaining payments with a trustee in escrow to be paid out on schedule. We provide theoretical justification for this option and show empirically that it allows inclusion of more covenants in bond issues. We highlight characteristics that make issuers likely to add a defeasance clause. In line with the model's prediction, the empirical analysis documents 13-24 basis points yield reduction for defeasible bonds - annual saving of about $1m, or $11m over the life of the average bond.