Asset Salability and Debt Maturity: Evidence from Nineteenth-Century American Railroads

Abstract

I investigate the effect of assets’ liquidation values on capital structure by exploiting the diversity of track gauges in nineteenth-century American railroads. The abundance of track gauges limited the redeployability of rolling stock and tracks to potential users with similar track gauge. Moreover, potential demand for both rolling stock and tracks was further diminished when many railroads went under equity receiverships. I find that the potential demand for a railroad’s rolling stock and tracks were significant determinants of debt maturity and the amount of debt that was issued by railroads. The results are consistent with liquidation values models of financial contracting and capital structure. (JEL G32, G33, L92, N21, N71) An extensive theoretical literature analyzes financial decisions from an “incomplete contracting” perspective. The driving force in this approach is the right to foreclose on the debtor’s assets in the case of default, and the theory predicts that optimal debt structure depends on how costly it is for creditors to liquidate assets. Despite the abundant theory, there is relatively little empirical evidence on the relation between liquidation value and debt structure. Testing the theory requires detailed information about the assets, their liquidation values, and the capital structure of the firm. Unfortunately, liquidation values are typically not observed by the econometrician, and crude accounting proxies such as fixed-asset ratio are far from being accurate. I provide empirical evidence on the link between liquidation values and debt maturity using a unique data set of nineteenth-century American railroads and exploiting variation in track gauges—the width of the tracks—to measure asset salability.