Hostname: page-component-78c5997874-lj6df Total loading time: 0 Render date: 2024-11-15T10:00:19.114Z Has data issue: false hasContentIssue false
  • English
  • Français

On the Call Provision in Corporate Zero-Coupon Bonds

Published online by Cambridge University Press:  06 April 2009

M. P. Narayanan  and
Suk-Pil Lim
Get access Rights & Permissions [Opens in a new window]

Abstract

A majority of corporate zero-coupon bonds includes a call provision, giving the firm the right to call the bond at par value. In this paper, we investigate whether or not it is optimal for the firm to call such a bond for refunding purposes, taking into consideration the effect of corporate taxes. We find that it is not optimal to refund the bond as long as the corporate tax rate is less than 50 percent. We find that a significantly higher proportion of callable zero-coupon bonds, compared to noncallables, has restrictive financing covenants, suggesting that the call feature is included to provide flexibility at a low cost for future recapitalizations as the firm's investment opportunities change.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 24 , Issue 1 , March 1989 , pp. 91 - 103
Copyright
Copyright © School of Business Administration, University of Washington 1989

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Arak, M., and Silver, A.. “The Value of the Tax Treatment of Original-Issue Deep-Discount Bonds: A Note.” Journal of Finance, 39 (03 1984), 253–259.Google Scholar
Barnea, A.; Haugen, R.; and Senbet, L.. “A Rationale for Debt Maturity Structure and Call Provisions in the Agency Theoretic Framework. Journal of Finance, 35 (12 1980), 1223–1234.CrossRefGoogle Scholar
Bodie, Z., and Taggart, R. A. Jr, “Future Investment Opportunities and the Value of the Call Provision on a Bond.”Journal of Finance, 33 (09 1978), 1187–1200.CrossRefGoogle Scholar
Boyce, W. M., and Kalotay, A. J.. “Tax Differentials and Callable Bonds.” Journal of Finance, 34 (09 1979), 825–838.CrossRefGoogle Scholar
Brick, I. E., and Wallingford, B. A.. “The Relative Tax Benefits of Alternative Call Features in Corporate Debt.” Journal of Financial and Quantitative Analysis, 20 (03 1985), 95–105.CrossRefGoogle Scholar
Chiang, R., and Narayanan, M. P.. “Bond Refunding in Efficient Markets—A Dynamic Analysis with Tax Effects.” Working Paper No. 87–17, J. Ira Harris Center for the Study of Corporate Finance, The Univ. of Michigan (1988).Google Scholar
Dunn, K., and Spatt, C.. “A Strategic Analysis of Sinking Fund Bonds.” Journal of Financial Economics, 13 (09 1984), 399–423.CrossRefGoogle Scholar
Fisher, L.; Brick, I. E.; and Ng., F. K. W. “Tax Incentives and Financial Innovation: The Case of Zero-Coupon and Other Deep Discount Corporate Bonds.” Financial Review, 18 (11 1983), 292–305.Google Scholar
Kalay, A. “Stockholder-Bondholder Conflict and Dividend Constraints.’ Journal of Financial Economics, 11 (07 1982), 211–233.CrossRefGoogle Scholar
Kalotay, A. “On the Management of Sinking Fund Bonds.” Financial Management, 10 (Summer 1981), 34–40.Google Scholar
Kalotay, A. “An Analysis of Original Issue Discount Bonds.” Financial Management, 13 (Autumn 1984), 29–38.CrossRefGoogle Scholar
Lewellen, W. G., and Emery, D. R.. “On the Matter of Parity among Financial Obligations.” Journal of Finance, 36 (01 1981), 97–111.CrossRefGoogle Scholar
Marshall, W., and Yawitz, J. B.. “Optimal Terms on the Call Provision on a Corporate Bond.” Journal of Financial Research, 3 (Fall 1980), 203–211.CrossRefGoogle Scholar
Myers, S. C. “Discussion.” Journal of Finance, 26 (05 1971), 538–539.Google Scholar
Ofer, A. R., and Taggart, R. A. Jr, “Bond Refunding: A Clarifying Analysis.” Journal of Finance, 32 (03 1977), 21–30.CrossRefGoogle Scholar
Robbins, E. H., and Schatzberg, J. D.. “Callable Bonds: A Risk-Reducing Signalling Mechanism.” Journal of Finance, 41 (09 1986), 935–950.Google Scholar
Smith, C., and Warner, J.. “On Financial Contracting: An Analysis of Bond Covenants.” Journal of Financial Economics, 7 (06 1979), 117–161.Google Scholar
Thatcher, J. “The Choice of Call Provisions: Evidence of Agency Costs of Debt.” Journal of Finance, 40 (06 1985), 549–561.Google Scholar
Yawitz, J. B., and Anderson, J. A.. “The Effect of Refunding on Shareholder Wealth.” Journal of Finance, 32 (12 1977), 1738–1746.CrossRefGoogle Scholar