CALL PROTECTION IN CONVERTIBLE BONDS: HOW MUCH AND WHY?

Timo P. Korkeamaki and William T. Moore

Convertible bonds typically feature both call provisions and call protection terms that revoke or limit issuers’ rights to call their bonds. We examine the determinants of the strength and the length of that call protection. Our findings suggest that issuers consider the timing of their future capital investment plans when designing their convertibles. Firms that expect to make subsequent investments sooner tend to offer weaker call protection. By retaining their ability to call, and thus force conversion to equity, issuers preserve flexibility to match the timing of their real options and the timing of financial options attached to their convertibles.