Why Firms Issue Callable Bonds: Hedging Investment Uncertainty

51 Pages Posted: 21 Mar 2007

See all articles by Zhaohui Chen

Zhaohui Chen

Independent

Connie X. Mao

Temple University - Fox School of Business and Management; Temple University - Department of Finance

Yong Wang

Independent

Date Written: March 12, 2007

Abstract

The paper models a firm's dynamic decisions: i) whether to issue a callable or non-callable bond; ii) when to call the callable bond; and iii) whether to refund it when it is called. We argue that callable bonds can be used to hedge investment risk, since they can resolve risk shifting problem when firms' investment opportunities are poor. Our empirical findings strongly support this argument. We find that firms facing poorer future investment opportunities are more likely to issue callable bonds. In addition, firms with higher leverage ratio and higher investment risk are more likely to issue callable bonds. Finally, as firms call back their bonds, non-refunding calls are associated with poor performance and low investment activities, and refunding calls are associated with good performance and high investment activities. Firms with mediocre performance and investment activities tend to not call their bonds.

Keywords: G31, G32

JEL Classification: Callable bond, debt agency problem, risky shifting

Suggested Citation

Chen, Zhaohui and Mao, Connie X. and Wang, Yong, Why Firms Issue Callable Bonds: Hedging Investment Uncertainty (March 12, 2007). Available at SSRN: https://ssrn.com/abstract=970596 or http://dx.doi.org/10.2139/ssrn.970596

Connie X. Mao

Temple University - Fox School of Business and Management ( email )

416 Alter Hall
Philadelphia, PA 19122
United States
215-204-4895 (Phone)
215-204-1697 (Fax)

Temple University - Department of Finance ( email )

Fox School of Business and Management
Philadelphia, PA 19122
United States
215-204-4895 (Phone)
215-204-1697 (Fax)

Yong Wang

Independent

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