Working Paper: NBER ID: w21919
Authors: Zhiguo He; Konstantin Milbradt
Abstract: A firm chooses its debt maturity structure and default timing dynamically, both without commitment. Via the fraction of newly issued short-term bonds, equity holders control the maturity structure, which affects their endogenous default decision. A shortening equilibrium with accelerated default emerges when cash-flows deteriorate over time so that debt recovery is higher if default occurs earlier. Self-enforcing shortening and lengthening equilibria may co-exist, with the latter possibly Pareto-dominating the former. The inability to commit to issuance policies can worsen the Leland-problem of the inability to commit to a default policy—a self-fulfilling shortening spiral and adverse default policy may arise.
Keywords: debt maturity; default timing; corporate finance
JEL Codes: G0; G01; G3; G30; G32; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| equity holders choose maturity structure of newly issued debt (G32) | default decisions (D91) |
| shortening of debt maturity structure (G32) | likelihood of default (G33) |
| deteriorating cash flows (G32) | likelihood of default (G33) |
| shortening of debt maturity structure (G32) | earlier defaults (Y20) |
| deteriorating cash flows (G32) | rollover losses (G32) |
| rollover losses (G32) | earlier defaults (Y20) |
| short-term bonds (G12) | earlier defaults (Y20) |
| long-term bonds (G12) | later defaults (G33) |
| shortening equilibrium (D50) | earlier defaults (Y20) |
| lengthening equilibrium (D50) | later defaults (G33) |