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Journal of Finance Vol. 41 No. 4 1986

Callable Bonds: A Risk‐Reducing Signalling Mechanism

Edward Henry Robbins; John D. Schatzberg1

1 Both authors are from the Department of Finance, College of Business and Public Administration, University of Arizona. Thanks go to the many individuals with whom we have had discussions about this material. We must particularly single out Sudipto Bhattacharya, David Brown, Willard Carleton, Charles

Abstract

The theory of financial economics has failed to distinguish advantages of callable bonds from those of short‐term debt. This paper shows that either type of borrowing can signal a firm's better prospects but that short‐term debt does so at the cost of weakened risk‐sharing with capital markets. By issuing either equity or long‐term, non‐callable debt, a firm with poor investment opportunities will not pool its prospects with those of a better firm. But equity produces superior risk‐sharing. Perhaps this explains the almost complete absence of long‐term, non‐callable bonds from observed corporate capital structures.

DOI
10.1111/j.1540-6261.1986.tb04558.x
Volume
41
Issue
4
Pages
935-949
Language
en
Sources
openalex crossref

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