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Why firms issue callable bonds: Hedging investment uncertainty

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  • Chen, Zhaohui
  • Mao, Connie X.
  • Wang, Yong
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    Abstract

    This paper analyzes 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 a firm uses a callable bond to reduce the risk-shifting problem in case its investment opportunities become poor. Our empirical findings support this argument. We find that a firm facing poorer future investment opportunities is more likely to issue a callable bond than a firm facing better investment opportunities. In addition, a firm with a higher leverage ratio and higher investment risk is more likely to issue a callable bond. Finally, after a callable bond is issued, a firm with a poor performance and a low investment activity tends to call back a bond without refunding; a firm with the best performance and highest investment activity tends to call back a bond and refund its call; and a firm with mediocre performance and investment activity tends to not call its bonds.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Corporate Finance.

    Volume (Year): 16 (2010)
    Issue (Month): 4 (September)
    Pages: 588-607

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    Handle: RePEc:eee:corfin:v:16:y:2010:i:4:p:588-607

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    Web page: http://www.elsevier.com/locate/jcorpfin

    Related research

    Keywords: Callable bond Debt agency problem Risky shifting Investment uncertainty;

    References

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    Cited by:
    1. Kim, Dong H. & Stock, Duane, 2014. "The effect of interest rate volatility and equity volatility on corporate bond yield spreads: A comparison of noncallables and callables," Journal of Corporate Finance, Elsevier, Elsevier, vol. 26(C), pages 20-35.

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