Short-Term Debt Overhang
57 Pages Posted: 5 Dec 2022
Date Written: November 18, 2022
We show that short-term debt in a firm’s optimal capital structure reduces investment under asymmetric information. Investors’ interpretation of underinvestment as a positive signal about the quality of the assets in place allows the equity holders to profit from short-term debt repricing at the rollover stage. Thus, underinvestment is more pronounced at shorter maturities, in contrast to Myers (1977). Low types' incentives to mimic put an endogenous constraint on high types' underinvestment payoff via a duration floor. Perhaps most strikingly, because cash lowers the duration floor, an increase in a firm’s retained earnings can decrease investment.
Keywords: debt overhang, adverse selection, capital structure, debt maturity, underinvestment
JEL Classification: G32
Suggested Citation: Suggested Citation