A common problem faced by many firms around the world is the scarce availability of long-term sources of funds. Exclusive reliance on short-term borrowing may expose companies to illiquidity risks and reduce their overall growth potential. To address these issues, many countries have embarked on policies promoting the development of long-term loan or bond markets with mixed results. However, while the negative implications of excessive short-term borrowing on growth and stability are well known (eg. Chang and Velasco, 2001 and Demirguc-Kunt and Maksimovic, 1998), there is no consensus on its underlying determinants and hence the main priorities for reform.
Under various assumptions, the decision to borrow at short-term maturities has been modelled in the corporate finance literature as a solution to debt-related agency problems (Barnea, Haugen and Senbet, 1980), or justified as a disciplinary tool to limit moral hazard (Rey and Stiglitz, 1993), as the result of coordination failures among banks (Dewatripont and Maskin, 1995), driven by the fear of early project termination by uninformed investors (Von Thadden, 1995), or as the consequence of illiquidity problems and inadequate regulation and institutions (Diamond and Rajan, 2000). In a signalling framework under asymmetric information, firms with favorable insider information may distinguish their quality by issuing short-term debt and roll it over, provided issuing costs are sufficiently high (Flannery, 1986, and Diamond, 1991).
This paper asks the question whether short-term lending is preferred by banks in credit markets where information about borrowers is relatively more opaque and there is a higher dispersion in the credit qualities of obligors. Most models in corporate finance analyze the choice of debt maturity from the perspective of the borrower, which chooses its debt maturity structure and optimizes from a variety of capital sources available in a developed country paradigm. Bearing in mind the credit constraints faced by firms in developing countries, this paper focuses on optimal debt maturity choice from the perspective of the lender. We study the conditions under which banks would lend short or long term under imperfect information about heterogeneous borrowers. The value of short-term lending in an information acquisition process is analyzed in a dynamic model under asymmetric information. As a complement to the hidden-action model by Rey and Stiglitz (1993) in “Short-term contracts as a monitoring device”, the hidden-information framework proposed in this paper emphasizes the benefits of short-term contracts as a screening device in high-risk credit markets. Building on Von Thadden (1995), we do not assume that monitoring is perfect and the lender learns the firm’s credit quality with certainty. Our paper models information acquisition as a screening process, through repeated short-term lending relationships, which may be more or less effective depending on the level of uncertainty in the micro-, macroeconomic as well as institutional environment.
The results of the model are then tested on empirical data of both developed economies and developing countries around the world. Although most existing empirical studies on corporate debt maturity focus on individual countries (mainly the US), there is a growing literature on how institutional differences across countries influence maturity choices (see, Dermirguc-Kunt and Maksimovic, 1999, Giannetti, 2003, and Fan, Titman and Twite, 2006). All of the above papers mainly focus on legal institutions of countries. A recent study by Djankov, McLiesh, and Shleifer (2006) analyzes the benefits of credit bureaus for the growth of private credit. Our study contributes to this line of research by investigating the impact of institutions aiming at reducing credit information asymmetries on the structure of corporate debt maturity. In particular, we focus on public and private credit bureaus and accounting standards as determinants of debt maturity structure after controlling for the impact of legal institutions, financial development and other macro and micro factors. The main findings of the paper can be summarized as follows.
From a theoretical standpoint, unlike in Hart and Tirole (1988), we find that it is possible for lenders to separate in equilibrium borrowers of different risk levels, under the assumption that higher-risk borrowers are more myopic, i.e. have higher time discount factors. In this case, repeated short-term contracting becomes an important mechanism for lenders to “learn” about the credit quality of borrowers. Our model shows that a high degree of information asymmetries in credit markets makes short-term lending the choice preferred by banks in equilibrium, although it may not be the socially optimal outcome.
In the empirical part of the paper, we assemble a novel cross-country database to test the main predictions arising from the model. Our main finding is that better credit information (as proxied by the existence and coverage of private and public credit registries as well as by improvements in accounting standards) is associated with a higher share of long-term debt as a proportion of total corporate debt in both developed and developing countries. We also find that countries with more uncertain legal frameworks are characterized by higher short-term debt. This suggests that short-term lending may be a valuable hedge against uncertainty from the lender’s perspective. Furthermore, countries with a lower dispersion of firms’ default probabilities are characterized by a higher ratio of short-term to total corporate debt. This is consistent with our theory of short-term lending being used by banks as a screening device when differences in default risks among firms are more opaque. Overall, our findings suggest that promoting institutions and policies to improve the quality of credit information around the world is an important prerequisite for increasing access of firms to long-term finance.
The paper is organized as follows. Section II reviews the literature on the determinants of the optimal choice of debt maturity. Section III presents a dynamic model of a bank choosing loan maturity under asymmetric information between the lender and the borrower, and discusses our main testable hypothesis. Section IV introduces the data and empirical results, and Section V concludes and draws some policy implications.
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Credit Information Quality and Corporate Debt Maturity: Theory and Evidence
