Debt callability and investment incentives

Lawrence D. Schall and Andrew F. Siegel

Journal of Corporate Finance, 2016, vol. 40, issue C, 315-330

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.

Keywords: Financing policy; Debt call option; Firm value; Investment incentives (search for similar items in EconPapers)
JEL-codes: G32 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:40:y:2016:i:c:p:315-330

DOI: 10.1016/j.jcorpfin.2016.08.004

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