The Sinking Fund Provision: Reinvestment Risk, Credit Improvement, and Growth Options
Tewari, Manish · Ramanlal, Pradipkumar
International Journal of Finance & Banking Studies · 2026 · Vol. / Issue · 01-19
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Abstract
We study the sinking fund provision in 1,533 nonconvertible corporate bonds issued from 1980 to 1996 with the year 1996 being the last year of inclusion for these provisions in fixed coupon non-convertible corporate bonds. The period 1980 to 1996 is classified as the period of high interest rates (Tewari, Byrd, and Ramanlal, 2015). We find that the provision addresses agency issues due to reinvestment risk, credit improvement, and growth options. When the interest rates are high, investment grade issues with sinking fund have longer maturities (> 20 years) by a ratio exceeding 4:1, while non-sinking fund issues have shorter maturities (≤ 20 years) by a ratio of about 2:1. High yield issues with sinking fund experience credit risk improvement, while non-sinking fund issues experience credit risk deterioration. When the rates are low and expected to rise, the provision is likely to present accumulation threat to the firm thereby, deterrent to its use by the firms. Also, firms use the sinking fund as a call option to capture the benefits of growth. These results suggest that the sinking fund provision has the potential to make a comeback in the corporate debt in a high-interest rate environment and when the rates are likely to fall. The current environment of persistent high rates presents conditions ripe for inclusion of the sinking fund provision in the corporate bonds.
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Tewari, Manish
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Ramanlal, Pradipkumar
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