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

48 Pages Posted: 22 Jan 2010 Last revised: 22 Aug 2012

Douglas W. Diamond

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Zhiguo He

University of Chicago - Booth School of Business, and NBER

Multiple version iconThere are 2 versions of this paper

Date Written: May 6, 2012

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.

Keywords: Wealth transfer, short-term debt crisis, underinvestment, endogenous default

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

Douglas W. Diamond

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
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773-702-7283 (Phone)

HOME PAGE: http://faculty.chicagobooth.edu/douglas.diamond/

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Zhiguo He (Contact Author)

University of Chicago - Booth School of Business, and NBER ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/zhiguo.he/pubs.html

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