Trade-off Model of Debt Maturity Structure

Trade-off Model of Debt Maturity Structure In this paper, we suggest the trade-off model to explain the choice of debt maturity. This model is based on balancing between risk and reward of using shorter-term loans. Shorter-term loans have cost advantage over, but incur higher refinancing and interest rate risk than longer-term loans. Using the Compustat data, we show that the principal components of financial attributes are financial flexibility and financial strength. Therefore, only firms with greater financial flexibility and financial strength can use proportionately more short-term loans. We also document that financially strong firms take advantage of lower interest rates of short-term debt. They use proportionately more short-term loans when the term premium is high. The results of our study also provide evidence supporting the agency cost hypothesis, which is strongly supported by current literature. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Trade-off Model of Debt Maturity Structure

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Publisher
Kluwer Academic Publishers
Copyright
Copyright © 2003 by Kluwer Academic Publishers
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1023/A:1022190205033
Publisher site
See Article on Publisher Site

Abstract

In this paper, we suggest the trade-off model to explain the choice of debt maturity. This model is based on balancing between risk and reward of using shorter-term loans. Shorter-term loans have cost advantage over, but incur higher refinancing and interest rate risk than longer-term loans. Using the Compustat data, we show that the principal components of financial attributes are financial flexibility and financial strength. Therefore, only firms with greater financial flexibility and financial strength can use proportionately more short-term loans. We also document that financially strong firms take advantage of lower interest rates of short-term debt. They use proportionately more short-term loans when the term premium is high. The results of our study also provide evidence supporting the agency cost hypothesis, which is strongly supported by current literature.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Oct 4, 2004

References

  • Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy
    Altman, E.
  • The Maturity Structure of Corporate Debt
    Barclay, M.; Smith, C.
  • On Financial Architecture: Leverage, Maturity, and Priority
    Barclay, M.; Smith, C.
  • A Rationale for Debt Maturity Structure and Call Provisions in the Agency Theoretical Framework
    Barnea, A.; Haugen, R.; Senbet, L.

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