The Maturity Structure of Corporate Debt

Barclay and Smith

JF 1995

 Executive Summary

Firms with higher information asymmetries issue shorter-term debt. Thus, growth firms issue more short-term debt as larger (and more regulated) firms use more long-term debt. This finding is consistent with the costly-contracting hypothesis. Further, there is little evidence that firms use debt maturities to signal.

Barclay and Smith categorize the existing literature on debt-maturities:

1. Contracting-cost hypothesis
2. Signaling hypothesis
3. Tax hypothesis

1. Contracting-cost Hypotheses

Myers (1977) introduced the underinvestment problem whereby leveraged firms pass up positive NPV projects since the benefits would accrue to debt-holders. This is more severe for firms with more growth-options. (Note the use of the word option--the firm can opt to not invest). "Issuing short-term debt avoids this problem. It fixes the price at which the firm repurchases its debt and allows stockholders to capture more 9if not all) of the benefits from its new investments." [Note in a footnote the similarity of this and a callable debt issue is discussed.]

This also assumes that "the cost of rolling over short-term debt is greater than the cost of issuing long-term debt." These costs "potentially include: (1) higher out of pocket floatation costs, (2) greater opportunity costs of management time in dealing with more frequent debt issues, and (3) reinvestment risk and potential costs of illiquidity."

This can also be a rationale for matching the debt maturity with the life of the asset being financed. If a firm does not match maturities, the firm may have the incentive to underinvest.

Banks have been shown to have a comparative advantage in monitoring. (James 1987) "To maximize the effectiveness of these monitoring activities, most bank loans are short-term….the bank maintains a stronger bargaining position." As this monitoring is most important for firms with large informational asymmetries, it is expected that these firms would use more bank loans and subsequently shorter-term loans.

Firm size may enter the picture on either side. It is possible that small firms will have shorter-term debt since they use private debt sales (read that as banks) more often. Moreover, foreign issues tend to be shorter term.

2. Signaling Hypotheses

Firm Quality- from the works of Flannery (1986) and Kale and Noe (1990) comes the hypotheses that if "the bond market cannot distinguish between high-quality and low quality firms, high quality (undervalued) firms will want to issue less underpriced short term debt." Both investors and poor quality firms realize this so it will result in 'high-quality firms issuing more short-term debt" while poor quality firms issue longer term (more overpriced) debt. Similarly, Flannery "argues that firms with large potential information asymmetries are likely to issue short-term debt because of the larger information costs associated with long-term debt."

Credit risk: Diamond (1991 and 1993) theorizes that as refinancing risk is low for high-quality firms, they are more likely to issue short-term debt. On the other hand, less creditworthy firms will issue longer-term debt. However, the very poor firms can not do this and are forced to issue short-term debt. Thus, the short end of the market is a combination of high quality and very-low quality firms.

3. Tax Hypothesis

"If the yield curve is upward sloping…Brick and Ravid (1985) argue that issuing long-term debt reduces the firm's expected tax liability….Conversely, if the term structure is downward sloping, issuing short-term debt increases firm value."

Data:

The sample is composed of Industrial firms (SIC from 2000-5999) for the years 1974-1992. Debt maturity is measured in years to maturity. (see Table 1)

(note: call and sinking fund provisions are ignored, so the effective maturity is actually less).

Methodology:

The authors us a regression with the dependent variable is maturity. The independent variables include market-to book (to proxy for growth opportunities), a regulation dummy, log of firm size, abnormal earnings, and term structure.

Findings:

1. Market to book is negatively significantly related to maturity. Thus higher growth firms have shorter maturities. This is significant for all tests.
2. Regulation dummy is positive and significant. Additionally the authors look at 4 industries that underwent deregulation. There was a reduction of maturity, however, due to the timing of the deregulation this could "be explained almost entirely by the more general trend in debt maturities."
3. Average Maturity has declined since 1976. In 1976 73% of debt was for longer than 3 years, in 1992 it was only 49.5%.
4. As expected from finding #1, there is a significant positive correlation between debt-maturity and dividend yield.
5. Regression results suggest that the dummy variable for access to public markets is positive while the dummy for access to the commercial paper market is negative.
6. As predicted by Diamond (1993), "a nonmontonic relation between credit standing and debt maturity" exists.
7. It does not appear that maturity is a significant means of signaling information to investors.
8. Taxes do not appear to be relevant with respect to maturity.

The authors conclude with some warnings. Specifically, they are only looking at debt outstanding, not debt at issuance. Further the research is not based on the specific mix of securities nor does it account for the possibility of early repayment.