Callable Bonds: A Risk‐Reducing Signalling Mechanism
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- Author(s): EDWARD HENRY ROBBINS, JOHN D. SCHATZBERG
- Published: Apr 30, 2012
- Pages: 935-949
- DOI: 10.1111/j.1540-6261.1986.tb04558.x
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.