Information Asymmetry and the Sinking Fund Provision
A large proportion of corporate bonds contain a sinking fund provision. The wide use of sinking funds has prompted both theoretical and empirical investigations. However, none has provided a satisfactory explanation for the existence of a sinking fund provision. The signalling implications of sinkin...
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| Format: | text |
| Language: | English |
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Institutional Knowledge at Singapore Management University
1993
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| Online Access: | https://ink.library.smu.edu.sg/lkcsb_research/808 |
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| Institution: | Singapore Management University |
| Language: | English |
| Summary: | A large proportion of corporate bonds contain a sinking fund provision. The wide use of sinking funds has prompted both theoretical and empirical investigations. However, none has provided a satisfactory explanation for the existence of a sinking fund provision. The signalling implications of sinking funds is examined, and it is shown that, under information asymmetry, the sinking fund amortization rate provides a credible signal for the quality of the firm. In a separating equilibrium, better quality firms choose higher sinking fund amortization rates in their bond issues. A latent index model is proposed for testing the hypothesis of sinking fund signalling. The empirical evidence indicates that the sinking fund amortization rate signals the credit quality of the firm. |
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