The Life Cycle of Make-Whole Call Provisions

Abstract

Make-whole call provisions are ubiquitous. While common perception is that the calls are rarely exercised, we demonstrate that bonds with make-whole call provisions are more than twice as likely to be retired early as equivalent non-callable bonds. Detailed analysis of these retirement events reveal four motivating rationales: 1) to refund the debt at what are perceived to be low current interest rates, 2) to eliminate restrictive covenants, 3) as a result of a merger or acquisition, often by a private equity group, and 4) as a mechanism for paying out excess cash, often generated by prior divestitures. Further analysis demonstrates that, despite paying a premium to retire the debt early, the firms actually save several million dollars on average relative to what the present value of their interest costs would have been if they waited a year to retire. Given the prevalence of restructuring driven early retirement, we conclude by analyzing whether firms with a large percentage of make-whole callable debt are more likely to be engaged in M&A transactions. Make-whole heavy firms are more likely to be M&A acquirers, but not more likely to be M&A targets.