Why Do Firms Issue Callable Bonds?

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. Disciplines Finance and Financial Management This working paper is available at ScholarlyCommons: http://repository.upenn.edu/fnce_papers/5 Why Do Firms Issue Callable Bonds? Amora Elsaify and Nikolai Roussanov November 15, 2016 Abstract Corporations in the US have signi cantly 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 rms issuing these bonds and their usage of the proceeds, which motivates a new theory for why rms desire these eternally "out of the money" call options. This theory captures the motives of rms in matching the maturities of investment and nancing and endogenously generates rm-speci c re nancing 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.Corporations in the US have signi cantly 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 rms issuing these bonds and their usage of the proceeds, which motivates a new theory for why rms desire these eternally "out of the money" call options. This theory captures the motives of rms in matching the maturities of investment and nancing and endogenously generates rm-speci c re nancing 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.