Debt Maturity Choice and Firms' Investment

66 Pages Posted: 20 Sep 2017

See all articles by Yongjin Kim

Yongjin Kim

City University of Hong Kong

Date Written: July 2, 2015

Abstract

This study revisits the relation between firms' choices of debt maturity and their investment in a dynamic world. Prior research, including Myers (1977), suggests that financing with short-term debt resolves the underinvestment problem caused by debt financing. In contrast, I establish that short-term debt can reduce the incentive to invest due to larger exposure to default risk from more frequent debt rollovers. Long-term debt, however, is more subject to illiquidity costs, so firms find optimal maturity by balancing these opposing forces. For the firm with average investment and financing, the agency cost arising from the underinvestment is 0.77% of firm value. This suggests that previous studies overestimate the cost by ignoring firms' flexibility in choosing maturity. I also measure firm-specific agency costs using likelihood-based structural estimation. The measured agency costs show significant cross-sectional variation due to heterogeneity in firm characteristics and convexity of the agency costs. The economy-wide average of the costs is 7.28%, which is considerably higher than the cost for the average firm.

Suggested Citation

Kim, Yongjin, Debt Maturity Choice and Firms' Investment (July 2, 2015). Available at SSRN: https://ssrn.com/abstract=3038633 or http://dx.doi.org/10.2139/ssrn.3038633

Yongjin Kim (Contact Author)

City University of Hong Kong ( email )

83 Tat Chee Avenue
Kowloon Tong
Hong Kong

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