Credit Risk and the Life Cycle of Callable Bonds: Implications for Corporate Financing and Investing

44 Pages Posted: 14 Jul 2021

See all articles by Bo Becker

Bo Becker

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); ECGI

Murillo Campello

Cornell University - Samuel Curtis Johnson Graduate School of Management; National Bureau of Economic Research (NBER)

Viktor Thell

Swedish FSA

Dong Yan

Stockholm School of Economics; Swedish House of Finance; Centre for Economic Policy Research (CEPR)

Date Written: June 2021

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.

JEL Classification: G21, G32, G33

Suggested Citation

Becker, Bo and Campello, Murillo and Thell, Viktor and Yan, Dong, Credit Risk and the Life Cycle of Callable Bonds: Implications for Corporate Financing and Investing (June 2021). CEPR Discussion Paper No. DP16239, Available at SSRN: https://ssrn.com/abstract=3886682

Bo Becker (Contact Author)

Stockholm School of Economics ( email )

Drottninggatan 98
Dept. of Finance
111 60 Stockholm, 11160
Sweden

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

ECGI ( email )

c/o the Royal Academies of Belgium
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Belgium

Murillo Campello

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

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369 Sage Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/Faculty-And-Research/Profile.aspx?id=mnc35

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138

Viktor Thell

Swedish FSA ( email )

Box 7821
Brunnsgatan 3
Stockholm
Sweden

Dong Yan

Stockholm School of Economics ( email )

Drottninggatan 98
Stockholm, 111 60
Sweden

Swedish House of Finance

Drottninggatan 98
111 60 Stockholm
Sweden

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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