Working Paper: NBER ID: w18160
Authors: Douglas W. Diamond; Zhiguo He
Abstract: Debt maturity influences debt overhang: the reduced incentive for highly- levered borrowers to make real investments because some value accrues to debt. Reducing maturity can increase or decrease overhang even when shorter-term debt's value depends less on firm value. Future overhang is more volatile for shorter-term debt, making future investment incentives volatile and influencing immediate investment incentives. With immediate investment, shorter-term debt typically imposes lower overhang; longer-term debt can impose less if firm value is more volatile in bad times. For future investments, reduced correlation between the value of assets-in-place and profitability of investment increases the overhang of shorter-term debt.
Keywords: debt maturity; debt overhang; investment incentives
JEL Codes: G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Short-term debt (H63) | lower overhang on immediate investments (G31) |
| Long-term debt (H63) | higher overhang on immediate investments (G31) |
| Short-term debt (H63) | increased volatility in future investment incentives (G31) |
| Increased volatility in equity value (G19) | stronger overhang in future investment scenarios (G31) |
| Reduced correlation between asset value and profitability (G19) | increased volatility in equity value (G17) |
| Fluctuating values of assets-in-place (G31) | different overhang dynamics based on timing of debt maturity (G32) |
| Short-term debt (H63) | earlier defaults (Y20) |
| Earlier defaults (Y20) | undermine future investment opportunities (G31) |