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Debt callability and investment incentives

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  • Schall, Lawrence D.
  • Siegel, Andrew F.

Abstract

Contrary to existing theory, even in perfect markets (with symmetric information, no taxes, and competitive, transaction costless capital markets) callable debt can induce investment incentives that are inferior (as well as superior) to those induced by non-callable debt, the outcome depending on cash flow and interest rate distributions. We derive necessary conditions for callable debt to induce inferior investment decisions, and define the “Call-Default Condition” as the cash flow distortion where calling prevents default that would have occurred with non-callable debt. These results complicate the argument that investment incentives explain the presence of the call provision in debt contracts.

Suggested Citation

  • Schall, Lawrence D. & Siegel, Andrew F., 2016. "Debt callability and investment incentives," Journal of Corporate Finance, Elsevier, vol. 40(C), pages 315-330.
    • Handle: RePEc:eee:corfin:v:40:y:2016:i:c:p:315-330
    DOI: 10.1016/j.jcorpfin.2016.08.004
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    Cited by:

    1. Eric Powers, 2021. "The Optimality of Call Provision Terms," Management Science, INFORMS, vol. 67(10), pages 6581-6601, October.
    2. Liang‐Chih Liu & Tian‐Shyr Dai & Lei Zhou & Hao‐Han Chang, 2022. "Analyzing interactive call, default, and conversion policies for corporate bonds," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(8), pages 1597-1638, August.

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    More about this item

    Keywords

    Financing policy; Debt call option; Firm value; Investment incentives;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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