Debt Maturity, Callability, and Dynamic Capital Structure

Abstract

In a dynamic framework, this paper studies a firm’s optimal capital structure choice in terms of the maturity and call premium of the debt. The firm’s capital structure is optimized accordingto a trade-off between a tax advantage of debt, bankruptcy costs and debt issuance costs. The central result of the paper is that the firm issues perpetual debt with a small positive call premium. This implies that debt restructuringis non-deterministic and that the call premium is the key parameter that controls the equity holders’ ex post restructuringincen tives. However, in the special case of non-callable debt we generally find that finite maturity is optimal.

Keywords: Maturity, Callability, Call Premium, Debt Choice, True Finite Maturity

JEL Classification: G13, G32, G33