Abstract
This paper shows that long debt maturities eliminate equityholders' incentives to reduce leverage when the firm performs poorly. By contrast, short debt maturities commit equityholders to such leverage reductions. However, shorter debt maturities also lead to higher transactions costs when maturing bonds must be refinanced. We show that this tradeoff between higher expected transactions costs against the commitment to reduce leverage when the firm is doing poorly motivates an optimal maturity structure of corporate debt. Since firms with high costs of financial distress benefit most from committing to leverage reductions, they have a stronger motive to issue short-term debt.
Highlights
Significant progress has been made towards understanding firms’ dynamic financing decisions
Dynamic leverage adjustments? How do firms optimally refinance expiring debt? What is the optimal debt maturity structure given its implications for dynamic capital structure adjustments and which firms are most likely to issue short-term debt? We address these questions in a framework that does not rely on information asymmetries or agency conflicts
(See Appendix A.6 for the proof of Proposition 6.) Bankruptcy costs, corporate taxes and critical debt maturity: We find that bankruptcy costs as well as the magnitude of the tax shield of debt financing represent the main determinants for the critical average maturity that triggers voluntary debt reductions
Summary
Significant progress has been made towards understanding firms’ dynamic financing decisions. We allow firms to choose the mix of debt and equity to repay maturing debt, whereas firms in the above models must roll over maturing debt with new debt issues, keeping the face value of total debt constant In contrast to these papers, we concentrate on debt maturity and its role in mitigating conflicts of interest between debtholders and equityholders on capital structure dynamics. While the existing literature assumes that the face value of debt is kept konstant at rollover dates, we allow firms to optimally choose the refinancing mix This implies that a firm’s leverage capacity increases if it chooses a capital structure which forces it to regularly roll over a non-trivial portion of its debt.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
