Event Date
“Make-Whole Clauses as Skin in the Game,” a joint paper with Dmitry Orlov
Make-whole provisions first appeared in the United States in the mid-1990s and are now a
feature of the vast majority of callable bonds publicly issued by non-financial firms. This rise to
prevalence is puzzling because, by design, make-whole clauses give issuers an acceleration option
that is almost always out of the money. We provide a rationale for these clauses by showing that
requiring issuers to pay above market value to retire existing debt contracts is essential when
conditioning those contracts on the arrival and quality of outside options is costly. Those clauses
help support the optimal level of effort on the part of issuers and enable issuers with weaker
outside options to credibly convey their types to lenders, which translates into better borrowing
terms and greater access to lending markets. This view also rationalizes all the salient design
features of make-whole clauses.
Link to paper: http://erwan.marginalq.com/index_files/wp_files/MW.pdf