Financial Contracting and Re-Rating Experience, the Cases of Make Whole, Claw Back and Other Wise Ordinary Callable Bonds

Abstract

The literature states that ordinary callable bonds help resolve several agency issues while make whole and claw back bonds are supposed to resolve the underinvestment problem. The justification for refinements of the classic call option is not clear as firstly, the classic call option seems able to handle the underinvestment problem anyway and secondly, the existing empirical evidence does not examine whether make whole and claw back bondholders actually benefit from the resolution of agency problems. We find evidence that firms’ do select make whole and claw back provisions to better confront the underinvestment problem for below investment grade bonds.