Abstract
I study the effect of information risk on firms’ financing policies in a model of dynamic leverage and dynamic debt maturity. New information affects credit spreads, and this is distinct from the effect of a cash shortfall on the borrowing need. Exposure to the volatility in credit spreads is value-reducing. To minimize the cost, firms pre-borrow — issue long-term debt before they need the funds, and keep proceeds in cash. Firms also prefer to spread the maturity dates, and use short-term debt only when close to financial distress and expect to delever in the future. ∗WU Vienna University of Economics and Business. Welthandelsplatz 1, A-1020 Vienna, Austria, phone: +43 1 313 36 5071, email: maria.chaderina@wu.ac.at. Previously circulated under the title “Pre-borrowing motive: A Model of Co-existent Cash and Debt Holdings”. I will always be greatfur to Rick Green for guidance and support. I would also like to thank Laurence Ales, Thomas Dangl, Brent Glover, Burton Hollifield, Yaroslav Kryukov, Lars-Alexander Kuehn, Christian Laux, Nicolas Petrosky-Nadeau and seminar participants at BI, WU Vienna University, HEC Lausanne, Copenhagen Business School, KHUST, Delaware, UBC, Washington University, Baruch and VGSF and participants of EFA 2012, SAET 2012 and 2012 Nordic Workshop for helpful comments and suggestions.
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