On the Maturity of Incremental Corporate Debt Issues

Introduction Firms are not only concerned with the amount of capital raised by a debt issue, but also with the timing of future cash flows that they use to return capital to bondholders. As noted by Guedes and Opler (1996), short-term debt allows firms to take advantage of information as it becomes public. It also can lead, however, to financial difficulty if the debt cannot be extended. Alternatively, long-term debt reduces the risk of liquidation, but it also can provide opportunities for underinvestment and risk shifting. Using a data source that has been researched extensively in the equity IPO literature but not yet applied to the examination of the maturity of corporate debt, we document the determinants of the maturity of 10,617 corporate debt issues placed by U.S. corporations in public markets between January 1, 1983 and December 31, 1999 as recorded in the SDC new issues database. We investigate and test various theories from earlier studies regarding optimal debt maturity suggesting that debt maturity is influenced by signaling and asymmetric information, taxes, and agency problems. Thus, our results serve as a summary and robustness check to prior empirical studies in the area of debt maturity. Our main finding is that firm quality, as measured by credit rating, is directly related to debt maturity. Although this finding is not consistent with a nonmonotonic structure in credit ratings and the signaling theory of debt, it does support the theory that risky firms are screened out of the long-term debt market. We also find evidence that supports a positive relation between the term structure and the maturity of debt issues, particularly for issues with fixed coupons. Although we do not find consistent results for the role of debt in mitigating agency problems, we do find evidence suggesting that debt maturity is inversely related to firm size. Finally, we find that regulated firms, excluding financial institutions, prefer long-term debt. Literature Review and Hypotheses Stiglitz (1974) analyzes the debt maturity question and shows that in a world without imperfections, assuming fully rational investors and managers, there is no optimal debt maturity. Introduction of market imperfections such as asymmetric information and signaling, taxes, or agency problems, however, leads to theories supporting preference for short-, intermediate-, or long-term debt. (1) Signaling and Asymmetric Information Flannery (1986) examines the maturity structure of a firm's risky debt using a model of uncertainty, with debt serving as a signal of credit quality. In Flannery's model, short-term debt signals an optimistic evaluation of the firm's prospects by insiders and long-term debt signals pessimism. (2) Also, Flannery's model shows that abnormally high refinancing costs will lead to a pooling equilibrium where high- and low-quality firms both issue long-term debt. Given a reasonable cost of debt issuance, however, a separating equilibrium develops in which low-quality firms self-select into long-term debt to avoid re-evaluation, but high-quality firms issue short-term debt because they can benefit from the refinancing process. Diamond (1991) suggests that high-quality firms want to use short-term debt but face the risk that refinancing may be unavailable, thus forcing liquidation and loss of control. Diamond's model shows that the optimal maturity structure is decided by a trade-off between the preference for short-term debt due to an expected improvement in the firm's credit rating and greater liquidity risk. The key implication is a nonmonotonic structure in credit ratings. That is, there are two types of short-term borrowers: the high-rated borrowers who use short-term debt to take advantage of the arrival of information and the low-rated borrowers who are screened out of the long-term debt market. Thus, long-term bonds are issued by firms with intermediate ratings. …