48 Pages Posted: 22 Jan 2010 Last revised: 22 Aug 2012
Date Written: May 6, 2012
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.
Keywords: Wealth transfer, short-term debt crisis, underinvestment, endogenous default
Suggested Citation: Suggested Citation
Diamond, Douglas W. and He, Zhiguo, A Theory of Debt Maturity: The Long and Short of Debt Overhang (May 6, 2012). AFA 2011 Denver Meetings Paper; Chicago Booth Research Paper No. 12-31; Fama-Miller Working Paper . Available at SSRN: https://ssrn.com/abstract=1539650 or http://dx.doi.org/10.2139/ssrn.1539650
By Ivo Welch