An Empirical Investigation of Debt Contract Design: The Determinants of the Choice of Debt Terms in Eurobond Issues

Maria do Rosario Correia (), Scott Linn and Andrew Marshall ()
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Maria do Rosario Correia: Faculdade de Economia da Universidade do Porto
Andrew Marshall: Accounting and Finance, University of Strathclyde

FEP Working Papers from Universidade do Porto, Faculdade de Economia do Porto

Abstract: This paper provides a comprehensive analysis of the determinants for the optimal choice of contract terms on Eurobonds issued by UK companies. We examine predictions of extant theories that associate the choice of debt features namely, maturity, call options, convertible options, and protective covenants to firm and market characteristics. Like in Correia (2003), a simultaneous equations approach is adopted to test the alternative use of contract features for mitigating debt-contracting costs. The evidence provides strong support to the prediction that both callable and short-term debt and convertible and debt with protective covenants are used as alternative control devises to mitigate agency costs. Further evidence suggests, however, that contrary to the fundamentals guiding the choice of maturity and callability structures, the use of conversion options and protective covenants in Eurobond contracts seems to be determined by equity agency costs rather than debt agency costs. Also, some support is found for the risk uncertainty theory underlying the use of convertibles and for liquidity risk arguments regarding the choice to include protective covenants.

Pages: 29 pages
Date: 2004-06
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