Does the Choice Between Fixed Price and Make Whole Call Provisions Reflect Differential Agency Costs?

Abstract

Bonds with either fixed price or make whole call provisions allow for the efficient recontracting of claims, but they differ in terms of their ability to mitigate debt agency costs. Controlling for the influence of bondholder-shareholder conflicts on both the level of covenant protection and selection of a particular type of call provision, we show that firms select call provisions with greater sensitivity to changes in the option-free value of the bond when agency problems are more severe. Our findings are consistent with the Barnea, Haugen and Senbet (1980) theorem that firms select fixed price callable debt to mitigate bondholder-shareholder conflicts.

Keywords: Fixed Price Call Provision, Make Whole Call Provision, Debt Agency Costs, Restrictive Covenants

JEL Classification: G12, G32