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

Christian Flor, Kirstine Boye Petersen and Alexander Schandlbauer

Journal of Corporate Finance, 2023, vol. 78, issue C

Abstract: We analyze what role debt overhang and covenants have in a manager’s choice between issuing callable or convertible debt when a firm needs to issue a substantial amount of debt. Callable bonds provide a higher coupon in exchange for a repurchase option. Convertible bonds offer bondholders the option to exchange debt to equity. Using a dynamic capital structure model with investment choice, we find that callable debt implies a larger debt overhang friction, and for highly leveraged firms convertible debt is preferred. Moreover, if outstanding bonds have net-worth covenants attached, callable bonds are more likely to be issued. Our empirical findings support the theory.

Keywords: Bond characteristics; Dynamic model; Growth option; Debt overhang; Covenants (search for similar items in EconPapers)
JEL-codes: D81 G31 G32 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:78:y:2023:i:c:s0929119922001894

DOI: 10.1016/j.jcorpfin.2022.102346

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