A RATIONALE FOR DEBT MATURITY STRUCTURE AND CALL PROVISIONS IN THE AGENCY THEORETIC FRAMEWORK

TLDR

Complex financial instruments are needed because markets cannot fully and cheaply solve the agency problems addressed. The paper introduces agency costs of debt to explain why such complex financial instruments exist. The study examines call provisions and debt maturity structures as the two key complexities. The paper shows that call provisions and maturity structures resolve agency problems stemming from informational asymmetry, managerial risk incentives, and foregone growth opportunities, and that both features serve the same purpose.

Abstract

ABSTRACT The agency costs of debt are introduced in this paper to explain the existence of complex financial instruments. Two areas of complexities are discussed in detail: the call provision and the maturity structure of debt. Their existence is rationalized as a means of resolving agency problems associated with informational asymmetry, managerial (stockholder) risk incentives, and foregone growth opportunities. It is also demonstrated that both features of corporate debt serve identical purposes in solving agency problems. Complex financial instruments are required because markets fail to provide complete and costless solutions to the agency problems discussed in the paper.