Finance Papers

Document Type

Working Paper

Date of this Version

11-15-2016

Abstract

Corporations in the US have significantly increased their usage of callable bonds in the past 10-15 years. Whereas callable debt was issued in the past for interest rate hedging motives, the vast majority of callable bonds issued today have call options that will enver be "in the money". This feature implies that previous explanations for the issuance of callable debt no longer rationalize the current pattern. We present evidence on the types of firms issuing these bonds and their usage of the proceeds, which motivates a new theory for why firms desire these eternally "out of the money" call options. This theory captures the motives of firms in matching the maturities of investment and financing and endogenously generates firm-specific refinancing risk. We then embed this theory into a production-based model and show that callable bonds can expand access to capital markets and increase investment.

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Date Posted: 27 November 2017