The Existence of Corporate Bond Clawbacks (IPOCs): Theory and Evidence

Clawback provisions allow the issuer to partially redeem a bond issue often within three years of issuance using proceeds only from new equity issues. Empirical evidence indicates the clawback provision is rarely exercised. This poses an interesting dilemma as clawback provisions are an expensive source of funding, often commanding yields that are significantly higher than traditional corporate bonds. We develop a simple model that provides a rationale for the scarcity of call redemptions and the higher yields of clawback bonds. The model predicts a relation between issuance of clawback bonds, cash flow volatility and the probability of renegotiation of clawback debt contracts that hinges on the existence of a separating equilibrium. Firms with stable cash flows and low growth opportunities issue bonds with clawback provisions while firms facing valuable growth opportunities prefer convertible bonds. The predictions of the model are tested and strongly supported by the empirical specifications.