Debt Overhang and the Life Cycle of Callable Bonds

Callable or convertible debt? The role of debt overhang and covenants

“…This finding is consistent with our model and with previous empirical literature, but differs from the theoretical predictions of Hennessy and Tserlukevich (2008). Furthermore, consistent with Becker et al (2021), there is a significant positive relationship between the issuance of a callable bond and the bond's maturity and offering amount. However, their paper focuses only on callable bonds and does not consider convertible bonds.…”

“…Chen et al (2010) analyze a firm's decision to issue a callable or non-callable bond and argue that callable bonds are used to reduce the risk-shifting problem in case investment opportunities become poor. Becker et al (2021) show that call features limit debt overhang by restricting value gains to corporate creditors. We add to these findings a detailed analysis of the tendency to issue either convertible or callable debt; we find that firms prefer to issue convertible bonds if financing needs are and debt overhang is an important issue.…”

Make-Wholes in Sovereign Bonds (Not Sure Why They Are There, but They May Be Free)

“…In this case, exercising the option could benefit the firm even if it has a financial cost. 21 This explanation is consistent with the finding of a survey of Chief Financial Officers (CFOs) showing that the most cited reason for issuing bonds with a make-whole call is the ability to retire 100% of a given bond issuance. 22 Interviews with corporate lawyers in the high-yield space on why they use these deep out of the money call options revealed the same rationale.…”

CLO Performance

“…In contrast, Becker et al. (2021) show that only one‐fifth of investment‐grade corporate bonds have a call feature, while three‐quarters of noninvestment‐grade corporate bonds are callable. As noted above, we track each tranche from origination through any refinancing events, so all else equal, a debt tranche that is refinanced to reduce its spread will have lower returns than a tranche that is not.…”