Hostname: page-component-8448b6f56d-tj2md Total loading time: 0 Render date: 2024-04-18T23:34:25.866Z Has data issue: false hasContentIssue false
  • English
  • Français

Dynamic Recapitalization Policies and the Role of Call Premia and Issue Discounts

Published online by Cambridge University Press:  06 April 2009

Edwin O. Fischer ,
Robert Heinkel  and
Josef Zechner
Get access Rights & Permissions [Opens in a new window]

Abstract

In a dynamic framework, the advantage of leverage depends upon the firm's recapitalization policy. We show that if bonds are callable at par, then equityholders have an incentive to recapitalize too early. Call premia and issue discounts, however, mitigate the agency problem of early recapitalization. The model provides the optimal call premium and issue discount as a function of firm-specific characteristics. An analysis of a bond sample supports the model's prediction that the optimal call premium is positively related to firm risk.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 24 , Issue 4 , December 1989 , pp. 427 - 446
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

Barnea, A.; Haugen, R. A.; and Senbet, L. W.. Agency Problems and Financial Contracting. Englewood Cliffs, NJ: Prentice-Hall Foundations of Finance Series (1985).Google Scholar
Bodie, Z., and Taggart, R. A.. “Future Investment Opportunities and the Value of a Call Provision on a Bond.” Journal of Finance, 33 (09 1978), 1187–1200.Google Scholar
Brealey, R., and Myers, S.. Principles of Corporate Finance. Second Edition, New York: McGraw-Hill (1984).Google Scholar
Brennan, M. J., and Schwartz, E. S.. “Optimal Financial Policy and Firm Valuation.” Journal of Finance, 38 (12 1983), 593–607.Google Scholar
Cox, J. C.; Ingersoll, J. E. Jr,; and Ross, S. A.. “An Intertemporal General Equilibrium Model of Asset Prices.” Econometrica, 53 (03 1985), 363–407.CrossRefGoogle Scholar
Dunn, K. B., and Spatt, C. S.. “The Effect of Refinancing Costs and Market Imperfections on the Optimal Call Strategy and the Pricing of Debt Contracts.” Working Paper, Carnegie-Mellon Univ. (03 1986).Google Scholar
Fischer, E. O.; Heinkel, R.; and Zechner, J.. “Dynamic Capital Structure Choice: Theory and Tests.” Journal of Finance, 44 (03 1989), 19–40.Google Scholar
Kalotay, A. J. “An Analysis of Original Issue Discount Bonds.” Financial Management, 13 (Autumn 1984), 29–38.CrossRefGoogle Scholar
Kane, A.; Marcus, A. J.; and McDonald, R. L.. “Debt Policy and the Rate of Return to Leverage.” Journal of Financial and Quantitative Analysis, 20 (12 1985), 479–499.CrossRefGoogle Scholar
Kraus, A. “An Analysis of Call Provisions and the Corporate Refunding Decision.” Midland Corporate Finance Journal, 1 (Spring 1983), 46—50.Google Scholar
Marshall, W., and Yawitz, J.. “Optimal Terms of the Call Provision on a Corporate Bond.” Journal of Financial Research, 3 (Summer 1980), 202–211.Google Scholar
Merton, R. C. “Theory of Rational Option Pricing.” The Bell Journal of Economics and Management Science, 4 (Spring 1973), 141–183.Google Scholar
Ronn, E. I., and Verma, A. K.. “A Multi-Attribute Comparative Evaluation of Relative Risk for a Sample of Banks.” Journal of Banking and Finance, 11 (09 1987), 499–523.CrossRefGoogle Scholar
Smith, C. W., and Warner, J. B.. “On Financial Contracting: An Analysis of Bond Covenants.” Journal of Financial Economics, 7 (06 1979), 117–161.CrossRefGoogle Scholar