Debt Overhang and the Life Cycle of Callable Bonds
47 Pages Posted: 17 Dec 2018
Date Written: December 17, 2018
Many US corporate bonds are callable at a predetermined, fixed price. Callability gives firms the ability to re-price their bonds ex-post. It is less clear how it resolves ex-ante contracting frictions. We show empirically that longer maturity and lower credit quality bonds are frequently issued with callable features. These bonds are often called when issuers experience improvements in credit quality. Firms with callable debt are more likely to increase investment following positive industry shocks. Such firms are also more likely to become takeover targets, confirming the prediction of a simple model we construct of debt overhang. The empirical patterns we report fit the theory that call features limit debt overhang by restricting value gains to corporate creditors.
Keywords: Callable bonds, debt overhang, credit risk
JEL Classification: G32, G33, G21
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