A Theory of Debt Maturity: The Long and Short of Debt Overhang

Authors

  • DOUGLAS W. DIAMOND,

  • ZHIGUO HE

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    • Douglas W. Diamond and Zhiguo He are with Booth School of Business, University of Chicago, and NBER. The authors gratefully acknowledge research support from the Center for Research in Security Prices at Chicago Booth. Diamond gratefully acknowledges support from the National Science Foundation under award number 0962321. They thank two referees, seminar participants at MIT Sloan, OSU Fisher, Chicago Booth, Columbia, Yale, Harvard, UCLA, NBER 2010 Corporate Finance meeting in Chicago, AFA 2011 in Denver, Southern Methodist University, NYU Stern, Nittai Bergman, Hui Chen, Victoria Ivashina, Gustavo Manso, Gregor Matvos, Henri Pages, Raghu Rajan, Berk Sensoy, Jeremy Stein, Rene Stulz, Sheridan Titman, and especially Stewart Myers and Charles Kahn for insightful comments.


ABSTRACT

Debt maturity influences debt overhang, the reduced incentive for highly levered borrowers to make real investments because some value accrues to debt. Reducing maturity can increase or decrease overhang even when shorter term debt's value depends less on firm value. Future overhang is more volatile for shorter term debt, making future investment incentives volatile and influencing immediate investment incentives. With immediate investment, shorter term debt typically imposes lower overhang; longer term debt can impose less if asset volatility is higher in bad times. For future investments, reduced correlation between assets-in-place and investment opportunities increases the shorter term debt overhang.

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