A Theory of Debt Maturity: The Long and Short of Debt Overhang

Abstract:     
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

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