Tag: Debt maturity

A Theory of Debt Maturity

The following post comes to us from Douglas Diamond, Professor of Finance at the
 University of Chicago Booth School of Business, and Zhiguo He of the
 Department of Finance at the University of Chicago Booth School of Business.

In our paper, A Theory of Debt Maturity: The Long and Short of Debt Overhang, forthcoming in the Journal of Finance, we study the effects of the debt maturity on current and future real investment decisions of an owner of equity (or a manager who is compensated by equity). Our analysis is based on debt overhang first analyzed by Myers (1977), who points out that outstanding debt may distort the firm’s investment incentives downward. A reduced incentive to undertake profitable investments when decision makers seek to maximize equity value is referred to as a problem of “debt overhang,” because part of the return from a current new investment goes to make existing debt more valuable.

Myers (1977) suggests a possible solution of short-term debt to the debt overhang problem. In part, this extends the idea that if all debt matures before the investment opportunity, then the firm without debt in place can make the investment decision as if an all-equity firm. Hence, following this logic, debt that matures soon—although after relevant investment decisions, as opposed to before—should have reduced overhang.


Corporate Finance Perspective on Large-Scale Asset Purchases

Editor’s Note: This post is based on the recent remarks of Jeremy C. Stein, a member of the Board of Governors of the Federal Reserve System, at the Third Boston University/Boston Fed Conference on Macro-Finance Linkages, which are available here.

Given that the conference theme is macro-finance linkages, I thought I would try to lay out a corporate finance perspective on large-scale asset purchases (LSAPs). I have found this perspective helpful in thinking both about the general efficacy of LSAPs going forward, and about the differential effects of buying Treasury securities as opposed to mortgage-backed securities (MBS). But before I get started, please note the usual disclaimer: The thoughts that follow are my own and do not necessarily reflect the views of other members of the Federal Open Market Committee (FOMC). I should also mention that these comments echo some that I made in a speech at Brookings last month. [1] As I noted in that speech, I support the Committee’s decision to purchase mortgage-backed securities (MBS) at a rate of $40 billion per month, in tandem with the ongoing maturity extension program in Treasury securities, and its plan to continue with asset purchases if the Committee does not observe a substantial improvement in the outlook for the labor market.


Capital Structure and Debt Maturity Choices

The following post comes to us from Joseph Fan, Professor of Finance at the Chinese University of Hong Kong; Garry Twite, Professor of Finance at the Australian National University; and Sheridan Titman, Professor of Finance at the University of Texas at Austin.

In the paper, An International Comparison of Capital Structure and Debt Maturity Choices, forthcoming in the Journal of Financial and Quantitative Analysis, my co-authors (Joseph Fan and Garry Twite) and I examine the influence of institutional environment on capital structure and debt maturity choices by examining a cross-section of firms in 39 developed and developing countries.

The country in which a firm resides has a greater influence on its capital structure than its industry affiliation. Specifically, a regression of firm leverage, measured as the book value of debt over the market value of the firm, on firm-specific variables, industry fixed effects and country fixed effects, has an adjusted R-square of 0.19. When the regression is estimated with industry but not country fixed effects, the adjusted R-square is reduced to 0.15. However, in a regression that includes country dummies but not industry dummies the adjusted R-square is reduced by only half as much, to 0.17. A similar regression with debt maturity, measured as the book value of long-term debt to the book value of total debt, as the dependent variable, has an R-square of 0.25, when all variables are included. When country fixed effects are excluded from the regression the R-square is substantially reduced to 0.09, but when the country fixed effect are included, but the industry fixed effects are excluded, the R-square is only slightly reduced to 0.23.


Executive Compensation and the Maturity Structure of Corporate Debt

This post comes to us from Paul Brockman, Professor of Finance at Lehigh University, Xiumin Martin, Assistant Professor of Accounting at Washington University, and Emre Unlu, Assistant Professor of Finance at the University of Nebraska.

In our paper, Executive Compensation and the Maturity Structure of Corporate Debt, which was recently accepted for publication in the Journal of Finance, we investigate the role of short-term debt in reducing agency costs of debt arising from executive incentive contracts. Specifically, we examine the effect of the two portfolio sensitivities on the maturity structure of corporate debt. In addition, we analyze the effect of debt maturity on the relation between portfolio sensitivities and bond yields.

We study the causal link between CEO incentive compensation and corporate debt maturity using a sample of 6,825 firm-year observations during the 14-year period from 1992 to 2005. We employ alternative definitions of short-term debt, follow Core and Guay’s (2002) method for estimating option sensitivities, and then apply several empirical methodologies (e.g., pooled OLS and GMM simultaneous equation estimation, fixed-effect regressions, change-invariables regressions) and an alternative new debt issuance sample to analyze the predicted relations.