Essays on Debt Maturity
I study firms' debt maturity decisions. I provide two models for optimal debt maturity choices when facing stochastic productivity and rollover risk. The first model is based on firms' need to smooth their capital when facing uncertainties in external financing. When the capital market freezes, new external financing is difficult. Firms with large debt repayments due have to forego good investment opportunities and in severe cases cut back on dividends. Long-term debt reduces immediate repayments and allows firms to keep the borrowed capital for future production. Therefore, when freezes are likely, firms respond by using more long-term financing and are better prepared. However, when the probability of freezes is low, firms turn to short-term financing. When a freeze suddenly occurs, the impact is significant and costly. The model predicts that constrained firms use more short-term debt. Based on the model, I propose investment-debt sensitivity as a new measure for financial constraints.
The second model depicts an economy in which entrepreneurs reallocate capital resources through borrowing and lending in either short-term or long-term debt. In expansions, productivity is more persistent and uncertainty in productivity is low, so entrepreneurs can better predict their future prospects. Hence, they choose to use more long-term debt to finance their productions. In recessions, future prospects are less clear to the entrepreneurs; therefore, they choose to use more short-term debt. The model explains the documented facts on pro-cyclical debt maturity in the economy. It also highlights that the shortening debt maturity structure causes capital resources to be less efficiently allocated in recessions further exacerbates the bad times. I argue that the change in the predictability of TFP drives pro-cyclical debt maturity, and that the maturity structure further amplifies the fluctuations in aggregate production.
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