Working Paper: CEPR ID: DP16239
Authors: Bo Becker; Murillo Campello; Dong Yan; Viktor Thell
Abstract: Call provisions allow bond issuers to redeem their bonds early. While commonly observed, existing research offers limited insight into the purpose of this contract feature. We show that bond callability is designed to mitigate agency problems, with call features and execution being determined by credit spreads and issuer quality. Callable bonds have significantly higher yields and lower secondary market prices than non-callable bonds ("cost of callability"). Issuers call bonds when their credit quality improves. We provide novel evidence that callability reduces debt overhang affecting decisions ranging from capital investment to takeovers. Our results help explain the prevalence of call features and suggest that callability improves economic efficiency.
Keywords: Callable Bonds; Credit Risk; Debt Overhang; Investment Decisions
JEL Codes: G32; G33; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Callable bonds (G12) | mitigate agency problems (G34) |
| Callable bonds (G12) | reduce debt overhang (H63) |
| Callable bonds (G12) | enhance corporate investment incentives (G31) |
| Callable bonds (G12) | predict higher probabilities of being acquisition targets (G34) |
| Callable bonds reduce debt overhang (H63) | positively influence investment decisions (G11) |
| Callable bonds limit gains for target debtholders during mergers (G32) | lower announcement returns (D39) |