Debt Maturity and the Dynamics of Leverage
52 Pages Posted: 25 Oct 2016 Last revised: 11 Jan 2018
Date Written: June 15, 2016
This paper shows that long debt maturities eliminate equity holders’ incentives to reduce leverage when the firm performs poorly. By contrast, short debt maturities commit equity holders to such leverage reductions. However, shorter debt maturities also lead to higher transactions costs when maturing bonds must be refinanced. We show that this tradeoff between higher expected transactions costs against the commitment to reduce leverage when the firm is doing poorly motivates an optimal maturity structure of corporate debt. Since firms with high costs of financial distress benefit most from committing to leverage reductions, they have a stronger motive to issue short-term debt.
Keywords: debt maturity, optimal capital structure choice
JEL Classification: G3, G32
Suggested Citation: Suggested Citation