The role of time value in convertible bond call policy

Abstract

Since the seminal work of Ingersoll (1977b) the optimal time in which a firm should redeem its outstanding convertible bonds has received large attention by the financial literature. Several studies have put forward a number of possible costs and benefits for a firm if it interrupts the life of its convertible bonds prior to their contractual maturity. However, in this paper we argue that the managerial decision to call back a convertible bond is mainly driven by a fundamental variable almost neglected up until now: the time value extraction from bondholders’ conversion option. Accordingly, we propose a measure for the effective convenience of calling—which we define as net time value advantage—and we show, using a survival analysis, that it is more effective than previously proposed measures in explaining the firms’ observed call policy.