Journal of Corporate Finance 20 (2013) 14–21

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Journal of Corporate Finance

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An empirical investigation of corporate bond clawbacks (IPOCs):Debt renegotiation versus exercising the clawback option☆

Kenneth N. Daniels a, Fernando Díaz Hurtado b, Gabriel G. Ramírez c,⁎a Virginia Commonwealth University, School of Business, Richmond, VA 23284-4000, USAb Universidad Diego Portales, Santiago, Chilec Kennesaw State University, Michael J. Coles College of Business, Kennesaw, GA 30144, USA

a r t i c l e i n f o

☆ Weare grateful for the comments of an anonymousAll-Georgia conferences, and at seminars at Coles CoBicentennial Program of Science and Technology throuresearch program at Virginia Commonwealth Universit⁎ Corresponding author at: Coles College of Busines

E-mail addresses: kndaniel@vcu.edu (K.N. Daniels1 IPOC stands for initial public offering clawbacked.

0929-1199/$ – see front matter © 2012 Published byhttp://dx.doi.org/10.1016/j.jcorpfin.2012.11.001

a b s t r a c t

Article history:Received 17 October 2011Received in revised form 26 October 2012Accepted 1 November 2012Available online 8 November 2012

Bond clawback provisions allow the issuer to partially redeem a bond issue often within3 years of issuance using proceeds only from new equity issues. We document that clawbackbonds are often renegotiated and clawbacks provisions are rarely exercised. We find that theprobability of exercising the clawback option increases if the firm has lower leverage, hasbetter return on equity, and is not issuing in the 144 market. We also find that the higher yieldsobserved on clawback bonds are associated with the likelihood of the clawback provisionbeing exercised. We argue that the results are consistent with the view that firms that useclawback provisions are likely to have better fundamentals. These firms exercise the clawbackprovision because the firm is able to access the equity markets and issue the needed equity forexercising the clawback option. Renegotiation of clawback bond results from the need torefinance the high cost IPOC issues and the difficulty accessing the equity capital markets.

© 2012 Published by Elsevier B.V.

JEL classifications:G32G33D22

Keywords:Clawback provisionsIPOCsBond clawbacksRenegotiationExercisingExchange offers

Introduction

Corporate bond clawbacks (IPOCs),1 sometimes called equity clawbacks, grew out of the high-yield debt market of the 1980s.The development of institutional investors with an appetite for high-yield debt, spurred by Drexel, Burham and Lambert, createdthe original issue high-yield debt market and increased the usage of the corporate bond clawback provision (Daniels et al., 2009).The clawback provision in an IPOC allows the debtor the option to redeem a preset fraction of the bond within a preset period at apredetermined price as long as the funds used for the debt redemption come from an equity offering.

IPOCs have three distinctive features. First, IPOCs are predominantly high-yield securities. Second, as documented in thispaper, corporate bond clawback provisions are rarely exercised. Third, IPOCs have a relatively short redemption window whichstarts immediately upon issuance and usually spans for up to 3 years. The existence of these features raises important questions

referee, the editor, participants at the Financial Management Associationmeetings, the firstWorld Finance, thellege of Business and Virginia Commonwealth University. This research has been partially funded by thegh a Social Science Ring, SOC-04, by the R&D grant program at Coles College of Business, and by the summery.s, Building 4, BB 411, 1000 Chastain Rd., Kennesaw, GA 30144, USA. Tel.: +1 770 423 6181.), fernando.diaz@udp.cl (F.D. Hurtado), gramirez@kennesaw.edu (G.G. Ramírez).

Elsevier B.V.

15K.N. Daniels et al. / Journal of Corporate Finance 20 (2013) 14–21

as to why and under what conditions the clawback options are exercised, and what impact it has on yields and debtrenegotiations. Extant literature on IPOCs is limited to a few papers empirically dealing with why IPOCs are used (Daniels et al.,2009; Goyal et al., 1998) and a theoretical model developed by Daniels et al. (2012) which analyzes the IPOC contract andestablishes conditions for IPOC issuance and conversion.

We studied corporate bonds with clawback provisions issued during the period 1993–2008. We find that the clawback featureis only exercised in 12.19% of the cases. We find that the likelihood of exercising the clawback is positively associated with firmshaving less leverage, greater return on equity, not using the 144 market for the IPOC issue, and having an investment grade rating.Given the high yields offered on IPOCs, it is not surprising that firms with relatively low leverage and higher return on equity thatachieve the needed access to the equity market would seek to extinguish the high costs of funds associated with the IPOC byexercising the clawback option. In fact, we find that firms that exercise the clawback provision tend to have a lower leverage ratioover time between issue date and the clawback expiration date, while firms that renegotiate their debt tend to have a higherleverage ratio over time between the issue date and the clawback expiration date. We also find that yields on IPOC issues arepositively associated with the probability of the clawback option being exercised. Bondholders of IPOCs and with exposure toreinvestment risk of the exercised option seek an additional premium of 80 basis points for the average firm in our sample.

The rest of the paper is structured as follows. Section 2 discusses the literature review and hypothesis development. Section 3presents the data and sample characteristics. Section 4 provides multivariate analysis and empirical results. Section 5 discussesthe results of the analysis.

2. Literature review and hypothesis development

Goyal et al. (1998) was the first paper on corporate bond clawbacks (IPOCs) and established that IPOCS are used by very smallfirms that are not very transparent to the public markets. Daniels et al. (2009) demonstrate that firms issue IPOCs because theseinstruments grant them access to the public debt markets and allows for the financial markets to improve the transparency of thefirm during the debt issuance process. In a paper not related to IPOCs, Huang and Ramírez (2010) find that firms that are typicallyrestricted from public markets use the 144a market as a stepping stone to reach public capital markets, as reflected in the fact thatthe majority of 144a issues are subsequently registered as public issues. It follows that firms that issue IPOCs would more likelyissue in the 144 market with the intention to register the 144a issues. Issuing in the 144a market is more expensive (Huang andRamírez, 2010) and IPOCs have higher yields than other financing instruments (Daniels et al., 2009). Therefore, we would expectthat firms exercise the clawback option when they are able to achieve access to the equity markets as a result of bettertransparency. We argue that firms that have an investment grade rating, though not often the case in the 144 market, wouldexhibit a higher degree of transparency and a better financial position. Besides an investment rating, these firms would need toshow that they have strong fundamentals, possibly captured by profitability measures. Firms who are not able to achieve theneeded access to equity markets would find it in their best interest to renegotiate the IPOC in order to lower the cost of debt. Inother words, we argue that firms that use the 144a market and issue IPOCs do not intend to carry the clawbacked bonds tomaturity and will either exercise the clawback provision and/or renegotiate the entire debt issue. Our analysis investigates whichfirm fundamentals influence whether a firm exercises the clawback provision or decides to renegotiate its debt.

We also provide insights into factors affecting debt renegotiations and the disposition of creditors to debt renegotiation(consistent with the Hennessy (2004) arguments for additional research on the role of renegotiation in debt contracts). Hart andMoore (1988) recognize that when cash flows are not verifiable the possibility of renegotiation is an important factor which mayhave an impact on the design of the original contract. Myers (1977) and Hart and Moore (1994) imply that when debtrenegotiation breaks down it generates a debt overhang which negates the ability of the firm to renegotiate with its creditors andjeopardizes the firm as an ongoing concern. Giving foreclosure on assets or the ability to impose bankruptcy on a firm does notalways give the creditor an advantage. Debt renegotiation has become a critical tool to alleviate the debt overhang problem and toavoid the high cost of firm liquidation. In addition, debt renegotiation recognizes that debt contracts cannot bind all firm behavioror explicitly cover every possible firm outcome in a cost efficient manner.2 Thus, creditors may anticipate the possibility ofrenegotiation which gives a degree of flexibility in the capital structure. Christensen et al. (2000) develop a model in which equityholders determine the renegotiating policy of the firm. Debt holders anticipate this renegotiation policy and price it accordingly asthey set the coupon rate. In this view, the renegotiation possibility and exercise policy of clawback debt is common knowledge ofdebt holders and should be priced accordingly by the market. In a similar fashion, we believe the clawback provision provides adegree of flexibility in the capital structure for a certain subset of firms which have the capability to take advantage of the option.In particular, firms which have access (or expect to attain access) to the capital markets, and that are seeking to reduce their debtpositions in the short run, may find the clawback provision a relatively useful tool. Compared to convertible bonds, IPOCs are bestsuited for this situation since a typical convertible bond has a significant protection period. An IPOC allows firms the ability toalter their capital structure soon after the issuance of debt. Wang and Noe (2000) illustrate that debt restructuring is strategic andthat fundamentally stronger firms seek to avoid renegotiation while severely distressed firms use renegotiation to theiradvantage. Our results are consistent with this view as fundamentally stronger firms are able to access the capital markets and

2 There is a large literature on incomplete contracts such as Aghion and Bolton (1992), Dewatripont and Tirole (1994) that recognizes complete contracts arecostly to design and may not be feasible given the inability to verify contingent cash flows under different state of natures.

16 K.N. Daniels et al. / Journal of Corporate Finance 20 (2013) 14–21

exercise the clawback provision, while firms with weaker fundamentals seek an advantage through renegotiation.,3 4 In ouranalysis, we explore the possibility that the decision to exercise the clawback provision or to renegotiate the IPOCs is related tothe firm's characteristics and contract features of the IPOC. This leads to our first hypothesis:

Hypothesis 1. Firm financial characteristics influence the probability of the clawback option to be exercised versus the renegotiation ofthe IPOC issue.

Obviously, not all IPOCs are either exercised or renegotiated and firms carry these instruments to maturity. While not the mainfocus of this paper, it is of general interest to know what financial characteristics are associated with these types of firms. Weargue that if a firm plans to carry an IPOC to maturity, these would more likely be observed for firms going directly to the publicmarkets. In results not reported in table form, we find support for this argument and in addition find that the yields for such IPOCsare lower than those in our sample, indicating, among other things, the more accessibility to public markets.

Daniels et al. (2009) also show that the option to use the clawback provision is relatively expensive compared to callable andstraight debt. Given that information asymmetries are generally greater for smaller firms, factors such as fewer analysts following,and the potential scarcity of firm resources to reduce information asymmetries may cause smaller firms to seek non-traditionalfinancing. In addition to size, prior research also documents that firms with poor credit ratings also suffer from problems of highinformation asymmetries. For example, Bodie and Taggart (1978), Thatcher (1985), Crabbe and Helwege (1994) show that firmshave used the call provision to mitigate information asymmetry problems. The clawback provision, however, may be moreattractive to certain firms, particularly if a firm has a better likelihood of issuing equity in the near term. Call provisions generallyhave long deferment periods. The average term for clawback exercise provision is generally shorter, less than 3 years on averageand the issuance of equity is generally considered a signal of potential good news (Goyal et al., 1998). The clawback provision alsohas the advantage to shareholders given the potential wealth gains for bondholders are lowered by retiring a portion of the debtwith equity proceeds.5 For these reasons, small firms and firms with lower credit ratings may prefer to use the 144a market andare not likely to be able to use the clawback provision. In any case, accessing debt markets with clawback debt may not be costlessfor these firms. Bondholders recognize the benefits to issuers and shareholders from these clawback provisions and price suchdebt accordingly. Debt with clawback features is, therefore, expected to be more costly than straight debt and clawback bondsthat are more likely to be exercised ex ante should experience higher yields relative to clawback bonds that are less likely to beexercised. We recognize that bondholders face substantial reinvestment risk if the clawback provision is exercised and the marketshould price this risk accordingly. This leads to our second hypothesis:

Hypothesis 2. Clawback bonds which are exercised should have higher offering yields than clawback bonds which are not exercised.

2. Data selection and sample construction

We first selected a sample of corporate bondswith clawback provisions.We obtained all the corporate bonds reported in the FixedIncome Security Database (FISD) that were flagged for clawbacks during the period 1993–2008. After cleaning the resultingobservations, eliminating repeated observations for 144A bonds,6 and matching with Bloomberg database and with exchange andtender offers data, the IPOC sample reduces to 1674 bonds that exercise a clawback provision or renegotiate (we also eliminate anyoverlapping decisions such as clawback bonds that are exercised and renegotiated such that all of our observations are mutuallyexclusive decisions). Aswe checked each bond issuewith Bloomberg to find out if the clawback optionwas exercised, we document ascarcity of clawback exercises. Only 204 of the 1,674 IPOCs were exercised representing an exercised rate of about 12.19%.7 Table 1presents the descriptive statistics for the sample which are split between exercised and renegotiated clawback bonds.

Panel A shows the frequency distribution of clawback bonds by year and Panel B shows the frequency distribution by industryclassification of the issuer. The 3-year period between 1997 and 1999 represents the highest rates of clawbacks being exercisedfollowed by the 2002 to 2005 period. Panel B shows that the financial sector, the retail sector, and the oil machinery industriesissued the most IPOCs and experienced a high number of exercised clawback issues (as do the food industry and utilities). Utilities

3 The clawback provision may be helpful in alleviating debt overhangs because it allows an issuer to circumvent the non-refundability of debt. Likesimultaneous tenders and calls (STACs), clawbacks represent a financial tool that allows the bond issuer to legally circumvent standard bond contractual features.STACs allow a firm to redeem non-refundable debt using clean cash (See Dhillon et al., 2001 for a detailed presentation). The legal dispute and court ruling inMacy's STAC in 1990 practically eliminated the viability of this tool.

4 We should also mention that private debt markets use the loan workout very frequently as a means to lower default rates and to provide financial continuityto firms experiencing financial distress. Private equity sponsors and loan arrangers work as a team to monitor their borrower such that changes in the financialstructure of the firm are an expected ongoing process. In a similar manner, the public debt market offers a degree of financial flexibility through the debtrenegotiation process.

5 Goyal et al. (1998) and Daniels et al. (2009) discuss how the clawback provision reduces the dilution problem and how monitoring costs are lowerconsequent to equity issuance.

6 Securities issued in the 144A market are unregistered securities that can be subsequently registered by exchanging the unregistered security for an identicalregistered security. FISD keeps both records and considers the registering as an exchange. We tracked down repeated cases in FISD and consolidated them to keepthe unregistered security information but consider in the analysis only registered securities. We also eliminated as part of this procedure cases in which a value of1 was assigned by FISD to a registration rights code. This implies the security has a clause that it needs to be registered within a certain time; often 180 days afterissuance. However, this variable does not fully reflect all 144A registrations that take place (see Huang and Ramírez, 2010). Accordingly, we further eliminatesecurities for which an exchange offer occurs within 180 days of issuance.

7 If the entire sample of IPOCs is considered (including those that do not renegotiate), this percentage reduces to about 5.3%.

Table 1IPOCs bond sample.

Panel A: yearly distribution of IPOCs exercised and renegotiated

Year Renegotiated Exercised Total

1993 42 6 481994 29 4 331995 43 8 511996 80 9 891997 142 15 1571998 207 5 2121999 130 13 1432000 77 14 912001 97 11 1082002 109 20 1292003 167 42 2092004 163 28 1912005 104 19 1232006 44 10 542007 30 0 302008 6 0 6Total 1,470 204 1,674

Panel B: industry distribution of IPOCs exercised and renegotiated

Industry Renegotiated Exercised Total

Automobiles 29 8 37Chemicals 68 7 75Clothing 30 3 33Construction 46 5 51Consumers 13 3 16Durable goods 49 2 51Fabric product 21 3 24Financials 97 14 111Food 47 10 57Machinery 60 14 74Mining 18 0 18Oil 65 16 81Others 736 89 825Retail 81 9 90Steel 34 3 37Transportation 52 7 59Utilities 24 11 35Total 1470 204 1674

*All of our categories are mutually exclusive so no issues are exercised and renegotiated.

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exercised about 31% of the IPOCs issued while mining did not exercise a single clawback. Other industries with very low exercisedrates are durable goods, construction and steel.

Bond sample and issuer characteristics are presented in Table 2.We evaluate the issuer at the issuance date and at the exercise date of the clawback to determine the change in fundamentals

between the two dates. At the issuance date, bonds with exercised clawbacks are relatively larger by issue size and asset size.However, the leverage between firms that renegotiate and firms that exercised the clawback are not significantly different at theissuance date. Also, clawback bonds have a higher offering yield and shorter maturity at the issuance date. However, at theexpiration date, bonds with the exercised clawback have lower leverage are still relatively larger by asset size, and are less likelyto be a noninvestment grade. Finally, we document that IPOCs have a redemption that averages about 35% per issue regardless ofwhether they are exercised or not and the bond and issuer characteristics of our sample are comparable to the samples ofprevious researchers such as Daniels et al. (2009) and Goyal et al. (1998).

3. Empirical analysis

In this section, we provide an empirical investigation of whether firm, issue, or market characteristics are determinants of thedecision to exercise or renegotiate clawback bonds. In our sample, issuers either exercise the clawback bond or renegotiate theclawback bond. We investigate the propensity to exercise the clawback bond in the following manner:

ExercisedClawbackBond ¼ f creditquality; issue and issuer characteristics;market accessð Þ: ð3:1Þ

Table 2IPOCs bonds sample and contract characteristics. This table presents the mean and standard deviation (in parenthesis) for several key variables on our samplecategorized by type of corporate action. The types of corporate action are non-exercised clawbacks, exercised clawbacks, no renegotiation and renegotiation. Thesample of clawbacks (IPOCs) represents the period 1993–2008. Data are obtained from FISD database and the Appendix has a description of all variables.

Total Renegotiated Exercised t Test for differences in means

t Statistic P value

At issuance dateOffering yield 10.04 9.98 10.47 −3.22 0.00

(2.04) (2.04) (2.00)Leverage 0.55 0.55 0.53 0.86 0.39

(0.25) (0.26) (0.24)S&P 8.52 8.54 8.37 1.27 0.10

(1.81) (1.77) (2.04)Log of assets 7.15 7.11 7.43 −3.04 0.00

(1.35) (1.35) (1.28)ROE −0.01 −0.01 −0.01 1.52 0.13

(0.05) (0.05) (0.03)Log of maturity 2.14 2.14 2.10 2.66 0.01

(0.01) (0.21) (0.22)Log of size 12,230 12,205 12,408 −3.46 0.00

(0.79) (0.80) (0.63)D144A 0.14 0.15 0.08 2.79 0.01

(0.35) (0.36) (0.27)At IPOC Date

Leverage 0.56 0.57 0.50 2.49 0.01(0.30) (0.30) (0.32)

Log of assets 7.34 7.31 7.59 −2.64 0.01(1.36) (1.36) (1.32)

ROE −0.02 −0.02 −0.01 −1.00 0.32(0.09) (0.09) (0.07)

18 K.N. Daniels et al. / Journal of Corporate Finance 20 (2013) 14–21

We proxy for CREDIT QUALITY using an ordinal variable for S&P credit ratings (S&P) where 1 represents AAA rating, 2represents Aaa, and so forth. Bonds with different credit ratings may have different market access. For instance, only investmentgrade bonds can be held by certain pension funds and this has a significant impact on the securities market demand. We expectthat credit quality may have an impact on the ability of a firm to exercise the clawback provision. In general, our expectation isthat firms with better credit quality are more likely to exercise the option. Our ISSUER CHARACTERISTICS is a vector of variablescapturing the nature and type of issuers and includes the log of total assets, leverage, and return on equity (ROE). Return onequity is computed as net income over book value of equity (both variables taken from Compustat or Bloomberg databases). OurISSUE CHARACTERISTICS is a vector of variables capturing the contract terms of each issue and include the log of the maturity andthe log of the issue amount (log of size). We use a dummy variable (D144a) to capture the firm's accessibility to public markets. Adescription of the variables is presented in the Appendix A.

We also estimate the relationship between these credit, issue and issuer characteristics and offering yields using an OLSregression. This relationship is expressed in the following manner:

Of f ering Yields ¼ f exercised; credit quality; issueandissuer characteristicsð Þ ð3:2Þ

Our main variable of interest is the dummy variable for the exercised clawback bond (exercised), which we expect to have apositive impact on the offering yield of the bond.

The testable form for the exercise of clawbacks Eq. (3.1) is:

Prob Exercise½ � ¼ Φ ðβ0 þ β1⋅ log of assetsþ β2⋅ROE þ β3⋅leverageþ β4⋅log of sizeþβ5⋅ log of maturityþ β6⋅S&P þ β7⋅144Aþ βi Di½ � þ μÞ: ð3:3Þ

We control for time trends and industry cross-sectional differences using a vector of dummies noted by Di. Φ(·) correspondsto the cumulative density function of the normal distribution.

We argue that firms with stronger accounting fundamentals are more likely to exercise the clawback provision. This impliesthat firms which choose to renegotiate have higher leverage, lower return on equity and are more likely to be a noninvestmentgrade firm.

We now turn our attention to the investigation of the IPOC yield. We use a multivariate analysis to estimate the determinantsof the yield. The functional form for the yield equation is:

YIELD ¼ β0 þ β1⋅EXERCISEþ β2⋅leverageþ β3⋅S&P þ β4⋅ log of assetsþβ5⋅ROEþ β6⋅ log of maturityþ β7⋅ log of sizeþ βi Di½ � þω ð3:4Þ

19K.N. Daniels et al. / Journal of Corporate Finance 20 (2013) 14–21

YIELD is the initial offering yield as reported in FISD database. All independent variables as defined previously. We control fortime trends and/or industries using the vector of dummies noted by Di and we also control for industry concentration using anOLS estimation accounting for clustering by industry.

The variable of particular interest to us is EXERCISE. While this variable is not known at the time of the bond issuance, it is usedto capture the investor's expectations that the firm will exercise the bond clawback. Corporate actions, such as exercising theclawback, are important strategic events and have consequences on the firm value along with a material impact on corporateinvestors. Davydenko and Strebulaev (2007) find that corporate actions are anticipated by the market and the effect of thecorporate action is stronger when creditors are particularly vulnerable to strategic threats, including risky firms with highmanagerial share holdings, simple debt structures, and high liquidation costs. From our model predictions and implications, weexpect a positive relationship between the EXERCISE and YIELD. Also, from existing studies such as Daniels et al. (2009), weexpect the size of the issue to be negatively related to YIELD. We further expect yields to be negatively related to the size of thefirm, return on equity, and maturity, while positively related to leverage and S&P rating dummy variable.

3.1. The likelihood of an exercised bond clawback

Table 3 presents the results of the exercised clawback probit regression (Eq. (3.4)).We estimate four models for Eq. (3.4). Model 1 is estimated without year and industry fixed effects. Model 2 is estimated with

year but without industry fixed effects. Model 3 is estimated without year but with industry fixed effects. Model 4 is estimatedwith year and industry fixed effects.

We find that the probability of a clawback being exercised is positively related to return on equity and negatively related toleverage. The regression coefficients are statistically significant at standard levels of significance. This implies that firms that aremorefundamentally sound in terms of profitability and solvency are more likely to exercise the clawback. In order to exercise, the marketmust perceive that these firms are transparent and strong enough to be able to issue equity. We argue that having strongfundamentals help firms establish themselves in the equity capital markets. Furthermore, an examination of the issue characteristicsshows that the size of the issue (log of size) has a significantly positive relationship with the propensity to exercise. The positivesignificant coefficient suggests greater transparency because larger issues involve more scrutiny in the underwriting process.

Our argument is that often IPOC firms are seeking access to the equity markets but are not candidates to issue in the publicmarkets, therefore, they go through the 144a market when seeking external funding other than bank loans.8 The significantnegative coefficient for the 144a dummy indicates that if a firm uses the 144a market to raise the original funds, it would be morelikely not to exercise the clawback option. We conjecture that this means that firms that use the 144a market find it difficult toestablish themselves in order to move up to the public equity markets and thus unable to issue the needed equity to exercise theclawback. Given the high costs of IPOCs, and the likely financial distress, these firms end up renegotiating their debt more often.These results are consistent with Hypothesis 1 and our a priori belief that relatively good accounting fundamentals are associatedwith an exercised clawback bond.

Also, our results (log of maturity) indicate that maturity has a significant negative relationship with exercise suggesting thatclawback bonds with longer maturities may be more likely candidates for renegotiation. This view is consistent with Roberts andSufi (2009) who find that longer maturity contracts are more likely to be renegotiated. Also, we find that 144A issues are alsomore likely to be renegotiated as indicated by the significant negative relationship with the propensity to exercise.

Additionally, we find that the firm size (log of assets) does not have a significant effect on the probabilities of exercising the bondissue. This is an interesting finding suggesting that firm size also does not impact the decision to renegotiate clawback debt.9

3.2. The impact of exercising the bond clawback on IPOC yields

As for the previous estimation, the estimation of Eq. (3.4) is also done with four models. The results are presented in Table 4.The focus of our attention in these regressions is on the EXERCISE dummy variable which is expected to capture the possible

impact of exercising the clawback provision on yields. Its coefficient ranges between 61.6 and 70.3 basis points and is significantat the 1% level. These results indicate that bond markets recognize the risk of early redemption (probability of exercising theclawback option) and prices the risk accordingly. Consistent with Hypothesis 2, our exercise premium is significant aftercontrolling for firm, issue and market risk.

An examination of the individual coefficients shows that most variables have the expected sign and coefficient. Leverage and thedummy variable for the credit quality has a positive and significant coefficient in both regressions. The log of assets has a significantnegative relationship indicating larger firms are able to obtain debt financing at lower cost. The coefficient of ROE is not statisticallydifferent from zero.Maturity (log ofmaturity) has negative and significant coefficients inModels 2 and 4 consistentwith Daniels et al.(2009). For brevity and space concerns, coefficients for year and industry dummies are not reported in the table.

8 In an analysis (not reported in the paper) of IPOCfirms that donot renegotiate vs. those that do renegotiate,wefind thatfirms that donot renegotiate use the publicmarkets more often (less likely to go 144a), have better return on equity, and are more likely to be a rated issued, and pay lower yield premiums. This supports ourargument that IPOC firms that use 144a market do so in order to access the capital markets and do not generally intend to carry the issue to maturity — it is eitherexercised or renegotiated.

9 Roberts and Sufi (2009) analyzed a set of loan contracts and found that firm fundamentals did not play a role in explaining renegotiation. Similarly, Dow(2012) shows that firms with a higher debt contract value of accounting values have a lower probability of renegotiation.

Table 3Exercise regression. This table presents the estimation of a probit model for the probability of exercising the clawback option in a sample of 1193 corporate bondsduring the period 1993 to 2008. The dependent variable is 1 if the IPOC is exercised and 0 if the IPOC is renegotiated. IPOCs that are not renegotiated or exercisedare not part of the sample. The independent variables are log_of_assets, ROE (return on equity), leverage as measured by total liabilities over total assets, log ofsize (natural log of the issue amount), log_of_maturity, a dummy variable, S&P,, that takes the value of 1 if the firm has a non-investment grade and zerootherwise, and a dummy, D144a, that takes the value of 1 if the firm uses the 144A market to issue the debt related to the IPOC. The table presents four modelsreflecting different fixed effects. The Hosmer–Lemeshow goodness of fit test for each equation is presented. P-values for regression coefficients are presented inparenthesis below the coefficient.

(1) (2) (3) (4)

Log of assets −0.02 −0.05 −0.03 −0.06(0.67) (0.32) (0.56) (0.26)

ROE 0.01 0.01 0.01 0.01(0.00) (0.00) (0.00) (0.00)

Leverage −0.46 −0.44 −0.36 −0.33(0.03) (0.03) (0.09) (0.10)

Log of size 0.21 0.24 0.20 0.24(0.02) (0.01) (0.03) (0.01)

Log of maturity −0.49 −0.47 −0.39 −0.40(0.03) (0.07) (0.09) (0.12)

S&P −0.02 −0.04 −0.02 −0.03(0.38) (0.20) (0.45) (0.28)

D144a −0.55 −0.55 −0.61 −0.61(0.01) (0.00) (0.00) (0.00)

Constant −2.04 −1.97 −1.54 −1.50(0.05) (0.07) (0.17) (0.21)

N 1,144 1,117 1,131 1,104LR χ2 37.32 65.57 71.52 106.21

(0.00) (0.00) (0.00) (0.00)Year effects No Yes No YesIndustry effects No No Yes YesHosmer–Lemeshow Goodness of Fit Test

χ2 6.13 14.67 8.36 7.32(0.63) (0.07) (0.40) (0.50)

20 K.N. Daniels et al. / Journal of Corporate Finance 20 (2013) 14–21

In conclusion, we present evidence consistent with Hypothesis 1 indicating firms with low leverage are likely to exercise theclawback provision while noninvestment grade firms are more likely to renegotiate their debt, and consistent with Hypothesis 2,firms that have very low probability of exercising the clawback provision should also have lower yields and that yields on IPOCsare associated, as expected, with the firm, issue and market risk.

Table 4Yield regression. This table presents the estimation of an OLSmodel for the relationship between IPOC yields and issue and firm characteristics as well as whether theclawbackoption is eventually exercised. The sample constitutes 1193 corporate bonds during the period 1993 to 2008 thatwere either exercised or renegotiated (IPOCsthat are not renegotiated nor exercised are not part of the sample). The dependent variable is the offering yield of IPOCs. The independent variables are log of assets, ROE(return on equity), leverage as measured by total liabilities over total assets, log of size (natural log of the issue amount), log of maturity, and a dummy variable, S&P,that takes the value of 1 if the firm has an S&P rating and zero otherwise. The table presents four models reflecting different fixed effects. P-values for regressioncoefficients are presented in parenthesis below the coefficient and are computed using heteroskedasticity robust standard errors.

(1) (2) (3) (4)

Exercise 0.62 0.66 0.68 0.70(0.00) (0.00) (0.00) (0.00)

Leverage 1.01 0.65 0.91 0.61(0.00) (0.00) (0.00) (0.01)

SNP 0.09 0.12 0.09 0.12(0.00) (0.00) (0.01) (0.00)

Log of assets −0.21 −0.06 −0.22 −0.07(0.00) (0.24) (0.00) (0.08)

ROE 0.01 0.01 0.01 0.01(0.95) (0.96) (0.90) (0.96)

Log of maturity 0.30 −1.12 0.26 −1.14(0.34) (0.00) (0.42) (0.00)

Log of size −0.11 −0.04 −0.15 −0.04(0.19) (0.62) (0.22) (0.63)

Constant 10.66 12.05 10.96 11.99(0.00) (0.00) (0.00) (0.00)

N 1,193 1,193 1,193 1,193R2 6.71% 27.51% 8.88% 29.13%Year effects No Yes No YesIndustry effects No No Yes Yes

21K.N. Daniels et al. / Journal of Corporate Finance 20 (2013) 14–21

4. Conclusion

The prevalence of IPOCs as an important source of capital for firms poses some interesting dilemmas for corporate managersand analyst of corporate bond markets. Why do firms rely on such an expensive source of corporate finance and seldom use theclawback option associated with IPOCs? In this paper, we presented an empirical analysis of the decision to exercise andrenegotiate corporate bond clawbacks. We find that the clawback provision is rarely exercised and that IPOCs are more oftenrenegotiated than exercised. We find that about 50% of the IPOC sample uses the 144a market to issue bonds that weresubsequently registered as public debt IPOCs. We argue that IPOC firms are often firms seeking access to capital markets and usethe 144a market as a step stone not intending to carry the debt issues to maturity. Therefore, once a firm is able to establish afoothold in the equity markets through more transparency and stronger fundamentals, the firm is able to issue the needed equityto exercise the clawback provision. Firms who are not able to pass the transparency threshold would then often renegotiate theentire debt issue. We provide evidence that, indeed, firms who renegotiate are more likely to have lower return on equity andhigher leverage than firms who exercise. We also provide evidence that firms that do not renegotiate their IPOCs are typicallyfirms that go directly to public markets, are smaller, have lower leverage, and pay lower yields than firms that renegotiate theirIPOCs.

Appendix A. Descriptions of Variables Used

Variable Description

EXERCISE Coded 1 if the firm exercises the clawback provision and 0 otherwise.D144A Coded 1 if the bond is a 144A offering, 0 otherwise.S&P An ordinal variable that captures the credit rating of the firm based on the S&P rating.Log of size The natural log of the size of issue.Log of assets The log of total assets of the firm.Leverage The leverage ratio is defined as total debt divided by total assets.Log of Maturity The natural log of the years to maturity of the issue.ROE The return on equity of the firm.Offering Yield The yield on the reference bond.

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