Sinking Funds and the Agency Costs of Corporate Debt

• Main Authors: KAO, Chihwa, WU, Chunchi
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 1990
• Subjects: Business; Corporate Finance
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/817
• Institution: Singapore Management University

A sinking fund provision typically obligates the firm to amortize a portion of the debt issue prior to maturity. A sample of 169 new industrial debt issues was used to examine whether firms with certain characteristics related to agency problems tend to incorporate a sinking fund provision in the bond indenture. Sets of debt-issue and issuer-related variables were constructed to characterize firms with agency problems. Empirical results from both logistic and linear regression models show that leverage ratio, profit ratio, time to maturity, dividend payout ratio, and the life of assets are important factors affecting the sinking fund decision of industrial firms. In general, firms with a high growth rate, high debt and dividend payout ratios, and a low profit ratio are inclined to adopt the sinking fund covenant. Also, the longer the maturity of debts and the shorter the life of the assets supporting these debts, the higher is the probability that a sinking fund provision will be included in the bond indenture.