Callable bonds, reinvestment risk, and credit rating improvements: Role of the call premium

We identify the call premium in nonconvertible callable bonds as an effective contracting provision to address agency conflict due to reinvestment risk and credit rating improvements. We analyze 4,495 bonds issued between 1980 and 2012. When interest rates are high, a majority of investment-grade issues and almost the entire subset with long maturities (>20 years) include a call premium. When interest rates are low, virtually all investment-grade issues with long and short maturities are callable at par. High-yield issues are limited to short maturities. By about 4:1, they include a call premium regardless of interest rate levels.