Callable or Convertible Debt? The Role of Debt Overhang and Covenants

50 Pages Posted: 23 Nov 2020

See all articles by Christian Riis Flor

Christian Riis Flor

University of Southern Denmark

Kirstine Boye Petersen

University of Southern Denmark

Alexander Schandlbauer

University of Southern Denmark

Date Written: October 8, 2020

Abstract

Many U.S. corporate bonds are either callable or convertible. While callable bonds provide a higher coupon to bondholders in exchange for a firm's repurchase option of its claim, convertible bonds offer investors the option to exchange a firm's debt to equity. This paper analyzes the choice between these two debt contracts. Using a dynamic capital structure theory model that includes an investment choice, we show that firms which are more exposed to debt overhang issue callable rather than convertible bonds. Convertible bonds are preferred if the firm has a higher initial level of debt. However, if bonds have covenants attached, the firm is more likely to issue callable bonds. Our empirical findings support the theory.

Keywords: Bond characteristics, dynamic model, growth option, debt overhang, covenants

JEL Classification: G31, G32, D81

Suggested Citation

Flor, Christian Riis and Petersen, Kirstine Boye and Schandlbauer, Alexander, Callable or Convertible Debt? The Role of Debt Overhang and Covenants (October 8, 2020). Available at SSRN: https://ssrn.com/abstract=3512488 or http://dx.doi.org/10.2139/ssrn.3512488

Christian Riis Flor (Contact Author)

University of Southern Denmark ( email )

Campusvej 55
Odense DK-5230
Denmark
+45 6550 3384 (Phone)
+45 6593 0726 (Fax)

Kirstine Boye Petersen

University of Southern Denmark ( email )

Campusvej 55
DK-5230 Odense, 5000
Denmark

Alexander Schandlbauer

University of Southern Denmark ( email )

Campusvej 55
Odense, 5230
Denmark

HOME PAGE: http://sites.google.com/site/alexanderschandlbauer/

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