The make-whole and Canada-call provisions: A case of cross-country spillover of financial innovation

Abstract

Almost all North American callable corporate bonds carry a make-whole call option. We trace the evolution of the US make-whole callable bond to the Canada-call that predates it by over eight years. This cross-country spillover of financial innovation continued at a slow pace. Six years after the US market initial adoption of make-whole bonds, AT&T introduced it to Europe. More than 10 years later, large European firms started issuing this financial instrument. The benefits and optimal exercise of the make-whole call provision are described. We provide a simple analysis that indicates the possibility for the optimal exercise of the make-whole call even when traditional analysis suggests a negative NPV of calling and refinancing the bond. Given the possibility of optimal exercise even when the make-whole call is seemingly out-of-the-money, we demonstrate how the effect of incentive alignment between stockholders and bondholders lowers the issuer’s cost of including a make-whole call provision below the issuer’s expected benefit of having the option to utilize such provision.