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 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.
Journal of Financial and Quantitative Analysis
Information Asymmetry and the Sinking Fund Provision. (1993). Journal of Financial and Quantitative Analysis. 28, (3), 399. Research Collection Lee Kong Chian School Of Business.
Available at: http://ink.library.smu.edu.sg/lkcsb_research/808