Corporate bond maturity decision: an agency and transaction cost explanation

Abstract

It is argued that firms make the choice of the term to maturity of a new corporate bond issue so as to minimize the aggregate of the agency costs and transaction costs. Issuing bonds with longer terms to maturity will allow firms to reduce the transaction costs associated with bond issues. However, the longer the term to maturity, the higher the agency costs associated with the issue. It is hypothesized that high agency costs associated with both the longer maturities and the default risk of a bond issue will force firms at high risk of default to issue short- or medium-term bonds. Bond covenants such as convertibility, the call provision, the sinking fund provision, and the put provision reduce agency costs of a bond issue. Therefore, firms at high risk of default will make use of such bond covenants to increase the term to maturity of a bond issue and consequently reduce the aggregate of the agency costs and transaction costs associated with debt. Firms with low default risk will be more flexible regard...