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Alternative Tests of Agency Theories of Callable Corporate Bonds

Author

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  • Leland E. Crabbe
  • Jean Hewlege

Abstract

According to agency theories, the prevalence of callable bonds arises from asymmetric information, a risk incentive or asset substitution problem, or an under investment problem. These theories are difficult to distinguish empirically because there are no direct measures of agency costs. Previous studies have found support for agency theories as a group, focusing on whether a bond has a call provision. We examine several areas in which the various theories are distinguishable: the subsequent rating changes of the bonds, the distribution of first call dates, the investment activity of bond issuers, and the value of the call options. We also examine trends in the use of call options over time. Based on a sample of industrial bonds issued between 1987 and 1991, our alternative tests provide evidence against the three agency theories. We conclude that agency theory, while potentially important for some firms, is unlikely to be the most important explanation of callable corporate bonds.

Suggested Citation

  • Leland E. Crabbe & Jean Hewlege, 1994. "Alternative Tests of Agency Theories of Callable Corporate Bonds," Financial Management, Financial Management Association, vol. 23(4), Winter.
    • Handle: RePEc:fma:fmanag:crabbe94
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    Cited by:

    1. Daniels, Kenneth & Diro Ejara, Demissew & Vijayakumar, Jayaraman, 2009. "An empirical analysis of the determinants and pricing of corporate bond clawbacks," Journal of Corporate Finance, Elsevier, vol. 15(4), pages 431-446, September.
    2. Mann, Steven V. & Powers, Eric A., 2003. "Indexing a bond's call price: an analysis of make-whole call provisions," Journal of Corporate Finance, Elsevier, vol. 9(5), pages 535-554, November.
    3. Lewis, Craig M. & Rogalski, Richard J. & Seward, James K., 1998. "Agency Problems, Information Asymmetries, and Convertible Debt Security Design," Journal of Financial Intermediation, Elsevier, vol. 7(1), pages 32-59, January.
    4. Goyal, Vidhan K. & Gollapudi, Neela & Ogden, Joseph P., 1998. "A corporate bond innovation of the 90s: The clawback provision in high-yield debt," Journal of Corporate Finance, Elsevier, vol. 4(4), pages 301-320, December.
    5. Isagawa, Nobuyuki, 2000. "Convertible debt: an effective financial instrument to control managerial opportunism," Review of Financial Economics, Elsevier, vol. 9(1), pages 15-26.
    6. John C. Banko & Lei Zhou, 2010. "Callable Bonds Revisited," Financial Management, Financial Management Association International, vol. 39(2), pages 613-641, June.
    7. Alderson, Michael J. & Lin, Fang & Stock, Duane R., 2017. "Does the choice between fixed price and make whole call provisions reflect differential agency costs?," Journal of Corporate Finance, Elsevier, vol. 46(C), pages 442-460.
    8. Brown, Scott & Powers, Eric, 2020. "The life cycle of make-whole call provisions," Journal of Corporate Finance, Elsevier, vol. 65(C).
    9. Jean Helwege & Christopher M. Turner, 1997. "The slope of the credit yield curve for speculative-grade issuers," Research Paper 9725, Federal Reserve Bank of New York.
    10. 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, vol. 26(C), pages 20-35.
    11. Eric Powers, 2021. "The Optimality of Call Provision Terms," Management Science, INFORMS, vol. 67(10), pages 6581-6601, October.
    12. Chen, Zhaohui & Mao, Connie X. & Wang, Yong, 2010. "Why firms issue callable bonds: Hedging investment uncertainty," Journal of Corporate Finance, Elsevier, vol. 16(4), pages 588-607, September.
    13. Levent Güntay & N. R. Prabhala & Haluk Unal, "undated". "Callable Bonds and Hedging," Center for Financial Institutions Working Papers 02-13, Wharton School Center for Financial Institutions, University of Pennsylvania.
    14. Kenneth Carow, 1999. "Evidence of Early-Mover Advantages in Underwriting Spreads," Journal of Financial Services Research, Springer;Western Finance Association, vol. 15(1), pages 37-55, February.
    15. Michael W. Becker & Michael S. Long, 1997. "An Explanation of Underwriting Spread Differentials on Complex Securities," Financial Management, Financial Management Association, vol. 26(2), Summer.
    16. Choi, Seungmook & Jameson, Mel & Jung, Mookwon, 2013. "The issuance of callable bonds under information asymmetry," Journal of Empirical Finance, Elsevier, vol. 21(C), pages 1-14.
    17. Nobuyuki Isagawa, 2000. "Convertible debt: an effective financial instrument to control managerial opportunism," Review of Financial Economics, John Wiley & Sons, vol. 9(1), pages 15-26, March.
    18. Daniels, Kenneth N. & Hurtado, Fernando Díaz & Ramírez, Gabriel G., 2013. "An empirical investigation of corporate bond clawbacks (IPOCs): Debt renegotiation versus exercising the clawback option," Journal of Corporate Finance, Elsevier, vol. 20(C), pages 14-21.
    19. Anderson, Christopher W., 1999. "Financial contracting under extreme uncertainty:: an analysis of Brazilian corporate debentures," Journal of Financial Economics, Elsevier, vol. 51(1), pages 45-84, January.

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