A Theory of Debt Maturity: The Long and Short of Debt Overhang
Douglas W. Diamond
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
University of Chicago - Booth School of Business
May 6, 2012
AFA 2011 Denver Meetings Paper
Chicago Booth Research Paper No. 12-31
Fama-Miller Working Paper
Debt maturity influences debt overhang: the reduced incentive for highly- levered borrowers to make real investments because some value accrues to debt. Reducing maturity can increase or decrease overhang even when shorter-term debt’s value depends less on firm value. Future overhang is more volatile for shorter-term debt, making future investment incentives volatile and influencing immediate investment incentives. With immediate investment, shorter-term debt typically imposes lower overhang; longer-term debt can impose less if firm value is more volatile in bad times. For future investments, reduced correlation between the value of assets-in-place and profitability of investment increases the overhang of shorter-term debt.
Number of Pages in PDF File: 48
Keywords: Wealth transfer, short-term debt crisis, underinvestment, endogenous default
Date posted: January 22, 2010 ; Last revised: August 22, 2012
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