Bankruptcy Code, Optimal Liability Structure and Secured Short-Term Debt

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When the Bankruptcy Code admits violations of absolute priority rules or results in collateral impairments to secured creditors, short-term debt with safe harbor protection emerges as a part of the optimal liability structure. However, the pledged collateral must satisfy a minimum liquidity threshold for the optimal issuance of safe harbored short-term debt. The ability of short-term creditors to refuse to roll over is a credible threat that makes short-term debt a natural candidate for safe harboring. Safe harbor rights lead firms to issue more short-term debt, less long-term debt, and increases the long-term spreads. Using the 1984 reform of the Code, we oer empirical evidence consistent with the predictions of the model.