FRIC/Finance Seminar with Josef Zechner, Vienna University of Economics and Business

FRIC Center for Financial Frictions and the Department of Finance are proud to announce the upcoming seminar with Josef Zechner, Vienna University of Economics and Business.

Josef Zechner will present

Debt Maturity and the Dynamics of Leverage

Authors:
Thomas Dangl, Vienna University of Technology
Josef Zechner, Vienna University of Economics and Business

ABSTRACT
This paper shows that long debt maturities destroy equityholders’ incentives to reduce leverage in response to poor firm performance. By contrast, a sufficiently short debt maturity commits equityholders to implement such leverage reductions. However, a short debt maturity also generates transactions costs associated with rolling over maturing bonds. We show that this tradeoff between higher expected transactions costs against the commitment to reduce leverage when the firm is doing poorly motivates an optimal maturity-structure of corporate debt. Since firms with high costs of financial distress benefit most from committing to leverage reductions, they have a stronger incentive to issue short-term debt. The debt maturity required to commit to future leverage reductions decreases with the volatility of the firm’s cash flows. We also find that the equityholders’ incentives to reduce debt is non-monotonic in the firm’s leverage. If the firm is pushed towards bankruptcy by a persistent series of low cash flows, then equityholders resume issuing debt to refinance maturing bonds, even when debt maturities are short.