Ebook The Determinants of Corporate Debt Maturity Structure
The copious literature on the choice between debt and equity dwarfs studies on the structure of debt maturity. Early works, for instance Merton (1974), assuming perfect capital markets, show the irrelevance of debt maturity structure in affecting firm value. Why firms use both short and long-term debts seems to be only partially understood under the existence of market imperfections.
The choice of debt maturity structure is important to firms since a badly chosen mix may cause an inefficient liquidation of a positive-NPV project. It can also be used by firms as a signalling device in an imperfect market to provide information about their quality, credibility and future prospects. According to signalling models, under-(over-)valued firms issue short-(long-)term debt to signal their under-(over-)valuation. Indeed, Fama (1990) suggests that maturity structure of corporate debt reflects the incentive to provide information, monitoring and bonding relevant for contracts.
The main debt maturity theories are as follows. The first strand is based on tax arguments. Brick and Ravid (1985) contend that when the term-structure of interest rates is upward sloping long-term debt is optimal since the savings from leverage due to interest tax shield is accelerated (borrower’s incentive) and recognition of interest income is delayed (lender’s incentive). Brick and Ravid (1991) further demonstrate the optimality of long-term debt even if yield curve is flat or downward sloping assuming interest rates are uncertain. Stohs and Mauer (1996) find some support for the tax effect while Guedes and Opler (1996) did not. Second strand is based on information asymmetries. Flannery (1986) predicts that high quality firms prefer short-term debt to signal their type. Stohs and Mauer (1996) provide empirical support to this. Diamond (1991) shows that even low-quality firms would prefer short-term debt due to liquidity risk; only medium-rated firms issue long-term debt. These arguments are empirically supported, among others, by Barclay and Smith (1995).
The third strand deals with contracting costs arguments. Myers (1977) argues that short-term debt mitigates underinvestment problem if it matures before growth options are exercised, as there remains an opportunity for lenders and firms to re-contract. Similarly, Barnea et al. (1980) argue that short-term debt may mitigate asset substitution problem since the value of short-term debt is less sensitive to changes in firms’ asset value. This contracting costs hypothesis is empirically supported by Barclay and Smith, and Guedes and Opler but not by Stohs and Mauer. Furthermore, asymmetric information arguments and contracting costs hypothesis argue that firms match the maturity of their assets and liabilities (Hart and Moore, 1994). This matching principle is heavily supported by extant empirical studies.
Early empirical studies examine the determinants of debt maturity only indirectly. Titman and Wessels (1988) find a negative correlation between size and short-term debt and argue that smaller firms cannot afford high issue costs of long-term debt. Mitchell (1991) suggests that unquoted firms are more likely to issue shorter-term debt due to information asymmetries. Mitchell (1993) finds a negative (positive) correlation between maturity and leverage (firm quality).
More recently, several papers examine the possible determinants of firms’ debt maturity decisions. Kim et al. (1995) report a significant positive relation between debt maturity, and leverage and firm size. Barclay and Smith (1995) find that larger firms with lower market to-book ratio have longer debt maturity. Guedes and Opler (1996) report that larger, better and the firms with higher growth opportunities are most likely to issue short term debt. Stohs and Mauer (1996), however, find only mixed support for an inverse relationship between debt maturity and market-to-book ratio. Ozkan (2000) reports negative relation of debt maturity with firm size and market-to-book ratio. Scherr and Hulburt (2001) find little evidence that tax status, growth options, and information asymmetries affect small firms’ debt maturity choice. However, the hypotheses related to capital structure, default probability and asset maturity are found to be relevant to maturity decisions of such firms.
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