Top Management Incentives and Financial Flexibility: The Case of Make-Whole Call Provisions

Consistent with the premise that make‐whole call provisions enhance value‐creating financial flexibility, we find that higher sensitivity of managerial wealth to stock price (delta) increases the likelihood that corporate bonds contain make‐whole provisions. Building on the results of related research, post‐issue financial performance of make‐whole callable bond issuers increases in delta. In line with prior findings that demonstrate financial flexibility can be costly to bondholders, we find that managerial equity incentives impact the incremental effect of make‐whole provisions on the pricing of corporate debt securities. Consistent with the flexibility explanation, we also find that the market response as measured by abnormal trading volume to the issuance of make‐whole callable debt varies in equity incentives. Overall, our results suggest that managerial incentives play a role in the choice, pricing, and market response to make‐whole options in corporate debt securities

Corporate Call Policy for Nonconvertible Bonds

We examine corporate call policy for 1,642 nonconvertible bonds that were called during the period 1975-94. The vast majority of firms delay calls and call when the bond price exceeds the call price. We find that larger, less liquidity constrained firms with a larger opportunity cost of delaying a call have shorter call delays. There is no evidence that refunding transaction costs, wealth redistribution effects, call notice periods, or a desire to eliminate restrictive covenants influence the timing of calls. An examination of call motives suggests that there is no one underlying motive that fits the average call

Going private transactions, bondholder returns, and wealth transfer effects

We examine how buyout activity and deal characteristics drive bondholder returns and the wealth transfer effects between bondholders and stockholders in going private transactions from 1981 to 2006. We find that various deal characteristics are major determinants of the cross-sectional variation in bondholder returns. In particular, a single private equity acquirer mitigates bondholder losses. On the other hand, bondholders have larger losses when a reputable buyout firm is involved in the deal. Bondholders experience losses in the 1980s and 2000s, but enjoy gains in the 1990s. Our findings remain robust to consideration of deal financing, relative cost of credit, and level of market overheating. We find a negative and significant relationship between stockholder and bondholder wealth effects, which supports the wealth transfer hypothesis.Bondholder wealth Buyouts Wealth transfer